[Federal Register Volume 87, Number 57 (Thursday, March 24, 2022)]
[Proposed Rules]
[Pages 16886-16977]
[FR Doc No: 2022-03212]

Vol. 87

Thursday,

No. 57

March 24, 2022

Part III

Securities and Exchange Commission

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17 CFR Part 275

Private Fund Advisers; Documentation of Registered Investment Adviser
Compliance Reviews; Proposed Rule

Federal Register / Vol. 87, No. 57 / Thursday, March 24, 2022 /
Proposed Rules

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release Nos. IA-5955; File No. S7-03-22]
RIN 3235-AN07

Private Fund Advisers; Documentation of Registered Investment
Adviser Compliance Reviews

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (the ``Commission'' or
the ``SEC'') is proposing new rules under the Investment Advisers Act
of 1940 (the ``Advisers Act'' or the ``Act''). We propose to require
registered investment advisers to private funds to provide transparency
to their investors regarding the full cost of investing in private
funds and the performance of such private funds. We also are proposing
rules that would require a registered private fund adviser to obtain an
annual financial statement audit of each private fund it advises and,
in connection with an adviser-led secondary transaction, a fairness
opinion from an independent opinion provider. In addition, we are
proposing rules that would prohibit all private fund advisers,
including those that are not registered with the Commission, from
engaging in certain sales practices, conflicts of interest, and
compensation schemes that are contrary to the public interest and the
protection of investors. All private fund advisers would also be
prohibited from providing preferential treatment to certain investors
in a private fund, unless the adviser discloses such treatment to other
current and prospective investors. We are proposing corresponding
amendments to the Advisers Act books and records rule to facilitate
compliance with these proposed new rules and assist our examination
staff. Finally, we are proposing amendments to the Advisers Act
compliance rule, which would affect all registered investment advisers,
to better enable our staff to conduct examinations.

DATES: Comments should be received on or before April 25, 2022.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (https://www.sec.gov/rules/submitcomments.htm); or
     Send an email to [email protected]. Please include
File Number S7-03-22 on the subject line.

Paper Comments

     Send paper comments to Vanessa A. Countryman, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.

All submissions should refer to File Number S7-03-22. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
website (https://www.sec.gov/rules/proposed.shtml). Comments are also
available for website viewing and printing in the Commission's Public
Reference Room, 100 F Street NE, Washington, DC 20549, on official
business days between the hours of 10:00 a.m. and 3:00 p.m. Operating
conditions may limit access to the Commission's public reference room.
All comments received will be posted without change; we do not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly.
    Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Christine Schleppegrell, Senior
Counsel; Thomas Strumpf, Senior Counsel; Melissa Roverts Harke, Senior
Special Counsel; Michael C. Neus, Private Funds Attorney Fellow; or
Melissa S. Gainor, Assistant Director, Investment Adviser Rulemaking
Office, or Marc Mehrespand, Branch Chief, Chief Counsel's Office, at
(202) 551-6787 or [email protected], Division of Investment Management,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-8549.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission (the
``Commission'') is proposing for public comment 17 CFR 275.206(4)-10
(new rule 206(4)-10), 17 CFR 275.211(h)(1)-1 (new rule 211(h)(1)-1), 17
CFR 275.211(h)(1)-2 (new rule 211(h)(1)-2), 17 CFR 275.211(h)(2)-1 (new
rule 211(h)(2)-1), 17 CFR 275.211(h)(2)-2 (new rule 211(h)(2)-2), and
17 CFR 275.211(h)(2)-3 (new rule 211(h)(2)-3) under the Investment
Advisers Act of 1940 [15 U.S.C. 80b-1 et seq.] (the ``Advisers Act'');
\1\ and amendments to 17 CFR 275.204-2 (rule 204-2) and 17 CFR
275.206(4)-7 (rule 206(4)-7) under the Advisers Act.
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    \1\ Unless otherwise noted, when we refer to the Advisers Act,
or any section of the Advisers Act, we are referring to 15 U.S.C.
80b, at which the Advisers Act is codified. When we refer to rules
under the Advisers Act, or any section of those rules, we are
referring to title 17, part 275 of the Code of Federal Regulations
[17 CFR part 275], in which these rules are published.
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Table of Contents

I. Background and Need for Reform
II. Discussion of Proposed Rules for Private Fund Advisers
    A. Quarterly Statements
    1. Fee and Expense Disclosure
    2. Performance Disclosure
    3. Preparation and Distribution of Quarterly Statements
    4. Consolidated Reporting for Certain Fund Structures
    5. Format and Content Requirements
    6. Recordkeeping for Quarterly Statements
    B. Mandatory Private Fund Adviser Audits
    1. Requirements for Accountants Performing Private Fund Audits
    2. Auditing Standards for Financial Statements
    3. Preparation of Audited Financial Statements
    4. Prompt Distribution of Audited Financial Statements
    5. Annual Audit, Liquidation Audit, and Audit Period Lengths
    6. Commission Notification
    7. Taking All Reasonable Steps To Cause an Audit
    8. Recordkeeping Provisions Related to the Proposed Audit Rule
    C. Adviser-Led Secondaries
    1. Recordkeeping for Adviser-Led Secondaries
    D. Prohibited Activities
    1. Fees for Unperformed Services
    2. Certain Fees and Expenses
    3. Reducing Adviser Clawbacks for Taxes
    4. Limiting or Eliminating Liability for Adviser Misconduct
    5. Certain Non-Pro Rata Fee and Expense Allocations
    6. Borrowing
    E. Preferential Treatment
    1. Recordkeeping for Preferential Treatment
III. Discussion of Proposed Written Documentation of All Advisers'
Annual Reviews of Compliance Programs
IV. Transition Period and Compliance Date
V. Economic Analysis
    A. Introduction
    B. Economic Baseline
    1. Industry Statistics and Affected Parties
    2. Sales Practices, Compensation Arrangements, and Other
Business Practices of Private Fund Advisers
    3. Private Fund Adviser Fee, Expense, and Performance Disclosure
Practices
    4. Fund Audits and Fairness Opinions
    5. Books and Records
    6. Documentation of Annual Review Under the Compliance Rule

    C. Benefits and Costs
    1. Overview and Broad Economic Considerations
    2. Quarterly Statements
    3. Prohibited Activities and Disclosure of Preferential
Treatment
    4. Audits, Fairness Opinions, and Documentation of Annual Review
of Compliance Programs
    5. Recordkeeping
    D. Effects on Efficiency, Competition, and Capital Formation
    1. Efficiency
    2. Competition
    3. Capital Formation
    E. Alternatives Considered
    1. Alternatives to the Requirement for Private Fund Advisers To
Obtain an Annual Audit
    2. Alternatives to the Requirement To Distribute a Quarterly
Statement to Investors Disclosing Certain Information Regarding
Costs and Performance
    3. Alternative to the Required Manner of Preparing and
Distributing Quarterly Statements and Audited Financial Statements
    4. Alternatives to the Prohibitions From Engaging in Certain
Sales Practices, Conflicts of Interest, and Compensation Schemes
    5. Alternatives to the Requirement That an Adviser To Obtain a
Fairness Opinion in Connection With Certain Adviser-Led Secondary
Transactions
    6. Alternatives to the Prohibition From Providing Certain
Preferential Terms and Requirement To Disclose All Preferential
Treatment
    F. Request for Comment
VI. Paperwork Reduction Act
    A. Introduction
    B. Quarterly Statements
    C. Mandatory Private Fund Adviser Audits
    D. Adviser-Led Secondaries
    E. Disclosure of Preferential Treatment
    F. Written Documentation of Adviser's Annual Review of
Compliance Program
    G. Recordkeeping
    H. Request for Comment
VII. Initial Regulatory Flexibility Analysis
    A. Reasons for and Objectives of the Proposed Action
    1. Proposed Rule 211(h)(1)-1
    2. Proposed Rule 211(h)(1)-2
    3. Proposed Rule 206(4)-10
    4. Proposed Rule 211(h)(2)-1
    5. Proposed Rule 211(h)(2)-2
    6. Proposed Rule 211(h)(2)-3
    7. Proposed Amendments to Rule 204-2
    8. Proposed Amendments to Rule 206(4)-(7)
    B. Legal Basis
    C. Small Entities Subject to Rules
    D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
    1. Proposed Rule 211(h)(1)-1
    2. Proposed Rule 211(h)(1)-2
    3. Proposed Rule 206(4)-10
    4. Proposed Rule 211(h)(2)-1
    5. Proposed Rule 211(h)(2)-2
    6. Proposed Rule 211(h)(2)-3
    7. Proposed Amendments to Rule 204-2
    8. Proposed Amendments to Rule 206(4)-(7)
    E. Duplicative, Overlapping, or Conflicting Federal Rules
    F. Significant Alternatives
    G. Solicitation of Comments
VIII. Consideration of Impact on the Economy
IX. Statutory Authority

I. Background and Need for Reform

    In the wake of the 2007-2008 financial crisis, Congress passed and
the President signed the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (``Dodd-Frank Act''), which increased the
Commission's oversight responsibility for private fund advisers.\2\
Among other things, the Dodd-Frank Act amended the Advisers Act
generally to require advisers to private funds to register with the
Commission and to require the Commission to establish reporting and
recordkeeping requirements for advisers to private funds for investor
protection and systemic risk purposes.\3\ The Dodd-Frank Act also added
section 211(h) to the Advisers Act, which, among other things, directs
the Commission to ``facilitate the provision of simple and clear
disclosures to investors regarding the terms of their relationships
with . . . investment advisers'' and ``promulgate rules prohibiting or
restricting certain sales practices, conflicts of interest, and
compensation schemes for investment advisers.'' \4\
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    \2\ Section 202(a)(29) of the Advisers Act defines the term
``private fund'' as an issuer that would be an investment company,
as defined in section 3 of the Investment Company Act of 1940 (15
U.S.C. 80a-3) (``Investment Company Act''), but for section 3(c)(1)
or 3(c)(7) of that Act. We use ``private fund'' and ``fund''
interchangeably throughout this release.
    \3\ See, e.g., Rule Implementing Amendments to the Investment
Advisers Act of 1940, Investment Advisers Act Release No. 3221 (June
22, 2011) (``Implementing Release''); Reporting by Investment
Advisers to Private Funds and Certain Commodity Pool Operators and
Commodity Trading Advisors on Form PF, Investment Advisers Act
Release No. 3308 (Oct. 31, 2011).
    \4\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
section 913(h), Public Law 111-203, 124 Stat. 1376 (2010).
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    Registration and reporting on both Form ADV and Form PF have been
critical to increasing transparency and protecting investors in private
funds and assessing systemic risk.\5\ They also have substantially
improved our ability to understand private fund advisers' operations
and relationships with investors as private funds play an increasingly
important role in the financial system and private funds continue
growing in size, complexity, and number. There are currently 5,037
registered private fund advisers with over $18 trillion in private fund
assets under management.\6\ In addition, private funds and their
advisers play an increasing role in the economy. For example, hedge
funds engage in trillions of dollars in listed equity and futures
transactions each month.\7\ Private equity and other private funds are
involved in mergers and acquisitions, non-bank lending, and
restructurings and bankruptcies. Venture capital funds provide funding
to start-ups and early stage companies. Private funds and their
advisers also play an increasingly important role in the lives of
everyday Americans saving for retirement or college tuition. Some of
the largest groups of private fund investors include state and
municipal pension plans, college and university endowments, non-profit
organizations, and high net worth individuals.\8\ Numerous investors
also have indirect exposure to private funds through private pension
plans, endowments, feeder funds established by banks and other
financial institutions, foundations, and certain other retirement
plans.
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    \5\ The Financial Stability Oversight Council uses these and
other tools to assess private fund impact on systemic risk. See also
U.S. Securities and Exchange Commission, Division of Investment
Management, Analytics Office, Private Fund Statistics, available at
https://www.sec.gov/divisions/investment/private-funds-statistics.shtml (providing a summary of private fund industry
statistics and trends based on data collected through Form PF and
Form ADV). Staff reports, statistics, and other staff documents
(including those cited herein) represent the views of Commission
staff and are not a rule, regulation, or statement of the
Commission. The Commission has neither approved nor disapproved the
content of these documents and, like all staff statements, they have
no legal force or effect, do not alter or amend applicable law, and
create no new or additional obligations for any person. The
Commission has expressed no view regarding the analysis, findings,
or conclusions contained therein.
    \6\ Form ADV data current as of November 30, 2021.
    \7\ See Division of Investment Management: Analytics Office,
Private Funds Statistics Report: First Calendar Quarter 2021 (Nov.
1, 2021) (``Form PF Statistics Report''), at 31, available at
https://www.sec.gov/divisions/investment/private-funds-statistics/private-funds-statistics-2021-q1.pdf (showing aggregate portfolio
turnover for hedge funds managed by large hedge fund advisers (i.e.,
advisers with at least $1.5 billion in hedge fund assets under
management) as reported on Form PF).
    \8\ See Form PF Statistics Report, supra at footnote 7, at 15
(showing beneficial ownership of all funds by category as reported
on Form PF). See also, e.g., Public Investors, Private Funds, and
State Law, Baylor Law Review, Professor William Clayton (June 15,
2020) (``Professor Clayton Article''), at 354 (noting that public
pension plans have dramatically increased their investment in
private funds).
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    During our decade overseeing most private fund advisers, our staff
has examined private fund advisers to assess both the issues and risks
presented by their business models and the firms' compliance with their
existing legal obligations.\9\ The

Commission also has pursued enforcement actions against private fund
advisers for practices that have caused private funds to pay more in
fees and expenses than they should have, which negatively affected
returns for private fund investors, or resulted in investors not being
informed of relevant conflicts of interest concerning the private fund
adviser and the fund.\10\ Despite our examination and enforcement
efforts, these activities persist.\11\
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    \9\ See, e.g., OCIE National Examination Program Risk Alert:
Observations from Examinations of Investment Advisers Managing
Private Funds (June 23, 2020) (``EXAMS Private Funds Risk Alert
2020''), available at https://www.sec.gov/files/Private%20Fund%20Risk%20Alert_0.pdf. As of December 17, 2020, the
Office of Compliance, Inspections and Examinations (``OCIE'') was
renamed the Division of Examinations (``EXAMS'').
    \10\ See, e.g., In re Kohlberg Kravis Roberts & Co. L.P.,
Investment Advisers Act Release No. 4131 (June 29, 2015) (settled
action) (alleging private fund adviser misallocated more than $17
million in so-called ``broken deal'' expenses to its flagship
private equity fund); In re Blackstone Management Partners L.L.C.,
et al., Investment Advisers Act Release No. 4219 (Oct. 7, 2015)
(settled action) (alleging private fund advisers failed to inform
investors about benefits that the advisers obtained from accelerated
monitoring fees and discounts on legal fees); In re NB Alternatives
Advisers LLC, Investment Advisers Act Release No. 5079 (Dec. 17,
2018) (settled action) (alleging private fund adviser improperly
allocated approximately $2 million of compensation-related expenses
to three private equity funds it advised).
    \11\ See, e.g., In the Matter of Diastole Wealth Management,
Inc., Investment Advisers Act Release No. 5855 (Sept. 10, 2021)
(settled action) (alleging private fund adviser failed to disclose
to investors that the adviser periodically made loans to a company
owned by the son of the principal of the advisory firm and that the
private fund's investment in the company could be used to repay the
loans made by the adviser); In re Global Infrastructure Management,
LLC, Investment Advisers Act Release No. 5930 (Dec. 20, 2021)
(settled action) (alleging private fund adviser failed to properly
offset management fees to private equity funds it managed and made
false and misleading statements to investors and potential investors
in those funds concerning management fee offsets); In the Matter of
EDG Management Company, LLC, Investment Advisers Act Release No.
5617 (Oct. 22, 2020) (settled action) (alleging that private equity
fund adviser failed to apply the management fee calculation method
specified in the limited partnership agreement by failing to account
for write downs of portfolio securities causing the fund and
investors to overpay management fees); In the Matter of Mitchell J.
Friedman, Investment Advisers Act Release No. 5338 (Sept. 4, 2019)
(settled action) (alleging that the co-owner of a private fund
advisory firm failed to disclose material conflicts of interest to
the private fund it managed and misled two investors by
misrepresenting an investment opportunity).
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    First, we continue to observe that private fund investments are
often opaque; advisers frequently do not provide investors with
sufficiently detailed information about private fund investments.
Without sufficiently clear, comparable information, even sophisticated
investors would be unable to protect their interests or make sound
investment decisions. For example, some investors do not have
sufficient information regarding private fund or portfolio company fees
and expenses to make informed investment decisions, given those fees
and expenses can be subject to complicated calculation methodologies
(that often include the application of offsets, waivers, and other
limits); may have varied labels across private funds; and can affect
individual investors' returns differently because of alternative fee
arrangements set forth in side letter agreements. In addition, advisers
often provide private fund investors with laundry lists of potential
fees and expenses, without giving details on the magnitude and scope of
fees and expenses charged. Beyond management fees, performance-based
compensation, and the expenses charged directly to the funds, some
private fund advisers and their related persons charge a number of fees
and expenses to the fund's portfolio companies. These can include
consulting fees, monitoring fees, servicing fees, transaction fees,
director's fees, and others. At the time of the initial investment and
as fund operations continue, many investors do not have sufficient
information regarding these fee streams that flow to the adviser or its
related persons and reduce the return on their investment.
    Investors also often lack sufficient transparency into how private
fund performance is calculated. Advisers frequently present fund
performance reflecting different assumptions, making it difficult to
measure and compare data across funds and advisers or compare the
fund's performance to the investor's chosen benchmarks, even where the
assumptions are disclosed. For example, one adviser may show fund
performance that reflects the use of a subscription line of credit
initially to fund investments and pay expenses rather than investor
capital. Another adviser may present only unlevered performance results
that do not reflect the effect of a subscription line. More
standardized requirements for performance metrics would allow private
fund investors to make apples to apples comparisons when assessing the
returns of similar fund strategies over different market environments
and over time. More standardized requirements for performance
information also would improve investors' ability to interpret complex
performance reporting, and assess the relationship between the fees
paid in connection with an investment and the return on that investment
as they monitor their investment and consider potential future
investments.
    Similarly, investors may not have information regarding the
preferred terms granted to certain investors (e.g., seed investors,
strategic investors, those with large commitments, and employees,
friends, and family). Advisers frequently grant preferred terms to
certain investors that often are not attainable for smaller
institutional investors or individual investors. In some cases, these
terms materially disadvantage other investors in the private fund.\12\
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    \12\ See, e.g., Securities and Exchange Commission v. Philip A.
Falcone, Harbinger Capital Partners Offshore Manager, L.L.C. and
Harbinger Capital Partners Special Situations GP, L.L.C., Civil
Action No. 12 Civ. 5027 (PAC) (S.D.N.Y.) and Securities and Exchange
Commission v. and (sic) Harbinger Capital Partners LLC, Philip A.
Falcone and Peter A. Jenson, Civil Action No. 12 Civ. 5028 (PAC)
(S.D.N.Y.), Civil Action No. 12 Civ. 5027 (PAC) (S.D.N.Y.), U.S.
Securities and Exchange Commission Litigation Release No. 22831A
(Oct. 2, 2013) (``Harbinger Capital'') (private fund adviser granted
favorable redemption and liquidity terms to certain large investors
in a private fund without disclosing these arrangements to the
fund's board of directors and the other fund investors). See also 17
CFR 275.206(4)-8 (rule 206(4)-8 under the Advisers Act).
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    This lack of transparency regarding costs, performance, and
preferential terms causes an information imbalance between advisers and
private fund investors, which, in many cases, prevents private
bilateral negotiations from effectively remedying shortcomings in the
private funds market. We believe that this imbalance serves only the
adviser's interest and leaves many investors without the tools they
need to effectively protect their interests, whether through
negotiations or otherwise. Moreover, certain advisers may only provide
sufficiently detailed information following an investor's admission to
the fund when the primary bargaining window has closed, particularly
for closed-end funds where investors have no, or very limited, options
to withdraw.
    Enhanced information about costs, performance, and preferential
treatment, would help an investor better decide whether to invest or to
remain invested in a particular private fund, how to invest other
assets in the investor's portfolio, and whether to invest in private
funds managed by the adviser or its related persons in the future. More
standardized information would improve comparability among private
funds with similar characteristics. This information also would help a
private fund investor better monitor and assess the true cost of its
investments, the value of the services for which the fund is paying,
and potential conflicts of interest. For example, enhanced cost
information could allow an investor to identify when the private fund
has incorrectly, or improperly, assessed a fee or expense by the
adviser contrary to the adviser's fiduciary duty, contractual
obligations to the fund, or

disclosures by the fund or the adviser. Ultimately, this information
would help investors better understand marketplace dynamics and
potentially improve efficiency for future investments, for example, by
expediting the process for reviewing and negotiating fees and expenses.
More competition and transparency also could lower the costs of capital
for portfolio companies raising money and increase returns to
investors, potentially bringing greater efficiencies to this part of
the capital markets.
    We also have continued to observe instances of advisers acting on
conflicts of interest that are not transparent to investors, provide
substantial financial benefits to the adviser, and potentially have
significant negative impacts on the private fund's returns.\13\ These
issues are widespread in the private fund context because, in many
cases, the adviser can influence or control the portfolio company and
can extract compensation without the knowledge of the fund or its
investors. In addition, private funds typically lack governance
mechanisms that would help check overreaching by private fund advisers.
For example, although some private funds may have limited partner
advisory committees (``LPACs'') or boards of directors, these types of
bodies may not have the necessary independence, authority, or
accountability to oversee and consent to these conflicts or other
harmful practices. Private funds also do not have comprehensive
mechanisms for private fund investors to exercise effective governance,
which is exacerbated by the fact that private fund advisers often
provide certain investors with preferential terms that can create
potential conflicts among the fund's investors. Moreover, the interests
of one or more private fund investors may not represent the interests
of, or may otherwise conflict with the interests of, other investors in
the private fund due to, among other things, business or personal
relationships or other private fund investments. To the extent
investors are afforded governance or similar rights, such as LPAC
representation, certain fund agreements permit such investors to
exercise their rights in a manner that places their interests ahead of
the private fund or the investors as a whole. For example, certain fund
agreements state that, subject to applicable law, LPAC members owe no
duties to the private fund or to any of the other investors in the
private fund and are not obligated to act in the interests of the
private fund or the other investors as a whole.
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    \13\ See, e.g., In the Matter of Bluecrest Capital Management
Limited, Investment Advisers Act Release No. 5642 (Dec. 8, 2020)
(settled action) (alleging that hedge fund adviser strategically re-
allocated its best performing personnel (traders) from its flagship
hedge fund to its proprietary hedge fund, which followed an
overlapping trading strategy and that hedge fund adviser failed to
adequately disclose the existence of its proprietary hedge fund, the
movement of traders, and related conflicts of interest); In the
Matter of Monomoy Capital Management, L.P., Investment Advisers Act
Release No. 5485 (Apr. 22, 2020) (settled order) (alleging that
private fund adviser charged the fund's portfolio company for the
services of its in-house operations group without fulling disclosing
this practice).
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    As an example of advisers acting on conflicts of interest, certain
venture capital fund advisers use private funds to obtain a controlling
or influential interest in a non-publicly traded early stage company
and then instruct that company to hire the adviser or its related
persons to provide certain services. In these circumstances, the
adviser often sets the terms of the engagement, including the price
paid for the services. In cases where the adviser causes the fund to
overpay for services because the services were not negotiated in an
arm's-length process, the adviser's practice of hiring its related
persons harms investors by diminishing the private fund's returns. For
example, the adviser sometimes instructs the company to pay certain of
the adviser's bills, to reimburse the adviser for expenses incurred in
managing its investment in the company, or to add to its payroll
adviser employees who manage the investment. In contrast, outside of
the private fund context, an adviser often uses private fund clients to
buy shares in a company and may vote proxies or engage with management
and the board, but absent taking some extraordinary steps, the
adviser's ability to influence or control the company is generally
constrained. In addition, if the company is publicly traded, the
adviser's attempts to seize control or make a variety of other changes
are generally visible to its clients and the public at large.
    Although many conflicts of interest can involve problematic sales
practices or compensation schemes, some can be managed. For example,
advisers have a conflict of interest with private funds and investors
in those funds when they value the fund's assets and use that valuation
as the basis for the calculation of the adviser's fees and fund
performance.\14\ Similarly, advisers or their related persons have a
conflict of interest with the fund and its investors when they offer
existing fund investors the option to sell or exchange their interests
in the private fund for interests in another vehicle advised by the
adviser or any of its related persons (an ``adviser-led secondary
transaction''). In both of these examples, there are opportunities for
advisers, funds, and investors to benefit, but there is also a
potential for significant harm if the adviser's conflicts are not
appropriately handled, including diminishing the fund's returns because
of excess fees and expenses paid to the fund's adviser or its related
persons. In these cases, enhanced protections in the form of an annual
private fund audit and a fairness opinion in connection with an
adviser-led secondary transaction would help address the concerns
presented by these conflicts.
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    \14\ See, e.g., SEC v. Joseph W. Daniel, Litigation Release No.
19427 (Oct. 13, 2005) and In re Joseph W. Daniel, Investment
Advisers Act Release No. 2450 (Nov. 29, 2005) (settled action)
(alleging adviser failed to properly value holdings of its hedge
fund client, which inflated the management fees investor paid); 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).
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    Other conflicts of interest are contrary to the public interest and
the protection of investors, and cannot be managed given the lack of
governance mechanisms frequent in private funds as discussed above. For
example, we have observed situations where the adviser causes one fund
to bear more than its pro rata share of expenses related to a portfolio
investment.\15\ In these circumstances, an adviser may unfairly
allocate fees and expenses to benefit certain favored clients at the
expense of others, indirectly benefiting the adviser. Through our
examinations, our staff also has encountered instances where advisers
seek to limit their fiduciary duty or otherwise provide that the
adviser and its related persons will not be liable to the private fund
or investors for breaching its duties (including fiduciary duties) or
liabilities (that exist at law or in equity).\16\ We believe an adviser
that seeks to limit its liability in such a manner harms the private
fund (and, by extension, the private fund investors) by putting the
adviser's interests ahead of the interests of its private fund client.
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    \15\ See, e.g., In the Matter of Lincolnshire Management, Inc.,
Investment Advisers Act Release No. 3927 (Sept. 27, 2014) (settled
action) (alleging private equity adviser to two private funds
misallocated expenses between the funds).
    \16\ See, e.g., EXAMS National Examination Program Risk Alert:
Observations from Examinations of Private Fund Advisers (Jan. 27,
2022) (``EXAMS Private Funds Risk Alert 2022''), available at
https://www.sec.gov/files/private-fund-risk-alert-pt-2.pdf.
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    Accordingly, based on our experience overseeing private fund
advisers, as well as private funds' impact on our financial

system, our economy, and American investors' savings, there is a need
to enhance the regulation of private fund advisers to protect
investors, promote more efficient capital markets, and encourage
capital formation. The Commission believes that many of the practices
it has observed are contrary to the public interest and protection of
investors and that these practices, if left unchecked, would continue
to harm investors.
    In addition, given the lack of strong governance mechanisms at
private funds, their compliance programs take on added importance in
protecting investors.\17\ We are proposing an amendment to the Advisers
Act compliance rule to require all SEC-registered advisers, including
those that do not manage private funds, to document the annual review
of their compliance policies and procedures in writing.\18\ Based on
staff experience, some investment advisers do not make and preserve
written documentation of the annual review of their compliance policies
and procedures, which our examination staff relies on to help it
understand an adviser's compliance program, determine whether the
adviser is complying with the rule, and identify potential weaknesses
in the compliance program. Advisers can also rely on written
documentation of the annual review to promote an internal culture of
compliance and accountability. We believe that requiring written
documentation would focus renewed attention on the importance of the
annual compliance review process and would result in records of annual
compliance reviews that would allow our staff to assess whether an
adviser has complied with the review requirement of the compliance
rule.
---------------------------------------------------------------------------

    \17\ Id.
    \18\ Proposed rule 206(4)-7(b).
---------------------------------------------------------------------------

II. Discussion of Proposed Rules for Private Fund Advisers

    We are proposing a series of rules under the Advisers Act that
would specifically address these practices by advisers to private
funds. The goal of this package of proposed reforms is to protect those
who directly or indirectly invest in private funds by increasing
visibility into certain practices, establishing requirements to address
certain practices that have the potential to lead to investor harm, and
prohibiting adviser activity that we believe is contrary to the public
interest and the protection of investors. While some of the investor
protection concerns identified herein may relate to an adviser's
activities with regard to other client types (e.g., separately managed
accounts, pooled vehicles that are not private funds as defined in the
Advisers Act), the proposed reforms are designed to address concerns
that arise out of the opacity that is prevalent in the private fund
structure. We also are proposing corresponding amendments to the books
and records requirements in rule 204-2.
    We request comment on the following aspects of the package of
proposed reforms:
     Are there certain activities that this package of proposed
reforms would address in the private fund context that we should also
address in other contexts (e.g., separately managed accounts)? Why or
why not?
     Are there certain activities in the private fund context
that this package of proposed reforms is not addressing but that we
should address?

A. Quarterly Statements

    The proposed rule would require an investment adviser that is
registered or required to be registered with the Commission to prepare
a quarterly statement that includes certain information regarding fees,
expenses, and performance for any private fund that it advises and
distribute the quarterly statement to the private fund's investors
within 45 days after each calendar quarter end, unless a quarterly
statement that complies with the proposed rule is prepared and
distributed by another person.\19\ We believe that periodic statements
detailing such information are necessary to improve the quality of
information provided to fund investors, allowing them to assess and
compare their private fund investments better. This information also
would improve their ability to monitor the private fund adviser to
ensure compliance with the private fund's governing agreements and
disclosures. While private fund advisers may currently provide
statements to investors, there is no requirement for advisers to do so
under the Advisers Act regulatory regime.
---------------------------------------------------------------------------

    \19\ Proposed rule 211(h)(1)-2.
---------------------------------------------------------------------------

    We believe advisers should provide statements to help an investor
better understand the relationship between the fees and expenses the
investor bears and the performance the investor receives from the
investment because of the opaque nature of the fees and expenses
typically associated with private fund investments. For example, a
private fund's governing documents (e.g., limited partnership
agreement, limited liability company agreement, or offering document)
may include broad characterizations of the types of potential fees and
expenses. In other cases, the fund's governing documents may give the
adviser significant discretion to determine which fees and expenses
relate to, and should be borne by, the fund. Examples of broad fee and
expense characterizations include ``any and all fees and expenses
related to the fund's business or activities,'' ``any and all fees and
expenses incurred in connection with the operation of the fund,'' and
``any and all fees and expenses that the adviser shall determine to be
related to the establishment and operation of the fund.'' These
provisions do not provide investors sufficiently detailed information
regarding what fees and expenses will be charged, how much those fees
and expenses will be, and how often fees and expenses will be charged.
    We believe that periodic statements containing certain required
information would allow investors to understand and monitor their
private fund investments better. For example, investors could check
fees and expenses paid directly or indirectly by the private fund
against the private fund's governing documents. This information may
allow an investor to identify when the private fund is incorrectly, or
improperly, assessed a fee or expense by the adviser contrary to the
adviser's fiduciary duty or the fund's governing agreements or
disclosures. As discussed in more detail below, the proposed quarterly
statement also would improve transparency for investors into both the
myriad ways an adviser and its related persons benefit from their
relationship with the private fund and the scope of potential conflicts
of interests.
    In addition, the proposed quarterly statement would allow a private
fund investor to compare cost and performance information across its
private fund investments. This information would help inform investment
decisions, including whether to remain invested in certain private
funds or to invest in other private funds managed by the adviser or its
related persons. More broadly, this disclosure would help inform
investors about the cost and performance dynamics of this marketplace
and potentially improve efficiency for future investments. For example,
if an investor owns interests in funds with similar investment
strategies, the investor may be in a better position to negotiate lower
fee rates for future investments because the investor would be aware of
the rates charged by certain advisers in that segment of the market.
    We recognize that many private fund advisers contractually agree to
provide

fee, expense, and performance reporting to investors. For example,
advisers may provide investors with financial statements, schedules, or
other reports regarding the fund and its activities. However, not all
private fund investors are able to obtain this information. Others may
be able to obtain information, but it may not be sufficiently clear or
detailed reporting regarding the costs and performance of a particular
private fund. For example, some advisers report only aggregated
expenses, or do not provide detailed information about the calculation
and implementation of any negotiated rebates, credits, or offsets.
Without clear, detailed disclosure, investors are unable to measure and
assess the impact fees and expenses have on their investment returns.
    Reporting practices also vary across the private funds industry due
to, among other things, different forms and templates. Because the
proposed requirement of quarterly statements would involve a degree of
standardization across the industry, we believe that investors would be
able to find and compare key information regarding fees, expenses, and
performance for funds with similar characteristics more easily than is
the case today. This has the potential to, in our view, bring greater
efficiencies to the marketplace by improving investor decision making.
For example, investors likely would be able to compare adviser
compensation across similar funds, which may assist investors in
determining whether to negotiate or renegotiate economic terms or
whether to invest or continue to invest in private funds managed by the
adviser.
    The proposed quarterly statement requirement would provide fund-
wide reporting. We believe this approach would help private fund
investors compare the costs of investing across private funds. We are
not proposing to require private fund advisers to provide personalized
account statements showing each individual investor's fees, expenses,
and performance. The proposed quarterly statements are designed, in
part, to allow individual private fund investors to use fund-level
information to perform more personal, customized calculations. In
addition, these proposed requirements do not prevent an adviser from
providing (or causing a third party, such as an administrator,
consultant, or other service provider, to provide), or an investor from
negotiating, personalized reporting. In the registered fund context,
fund-level reporting has, in our view, enabled retail investors to
understand their investments better. We believe a comparable approach,
but one that is more suitable to the needs of investors in private
funds, is appropriate here.
    We request comment on the following aspects of the proposed rule:
     Should we, as proposed, require advisers to private funds
to prepare a quarterly statement providing standardized disclosures
regarding the cost of investing in the private fund and the private
fund's performance and distribute the quarterly statement to the fund's
investors? Should we instead require advisers to provide investors with
personalized information that takes into account the investors'
individual ownership stake in the fund in addition to, or in lieu of, a
statement covering the private fund? If so, what information should be
included in the personalized disclosure? For example, should the
statement reflect specific fee arrangements, including any offsets or
waivers applicable only to the investors receiving the statement? Do
advisers currently provide personalized fee, expense, and performance
disclosures? If so, what other types of information do advisers or
funds typically include? Do they automate such disclosures? How
expensive and complex would it be for advisers to create and deliver
personalized disclosures? How useful would it be for investors to
receive personalized disclosures?
     Would investors find data regarding the private fund's
fees, expenses, and performance useful given that certain investors may
have different economic arrangements with the adviser, such as fee
breaks or expense caps? Should we require advisers to disclose in the
quarterly statement whether investors are subject to different economic
arrangements, whether documented in side letters or other written
agreements or, to the extent applicable, as a result of different class
terms? If so, should we require advisers to list the rates or otherwise
show a range?
     Should the quarterly statement rule apply to registered
advisers to private funds as proposed or should it apply to all
advisers to private funds? Should it apply to exempt reporting
advisers? Should the rule include any exceptions for categories of
advisers? If so, what conditions should apply to such an exception?
     Should the rule require advisers to prepare and distribute
the quarterly statements only to private fund investors, as proposed?
Alternatively, should the rule require advisers to provide quarterly
statements to investors in other types of pooled investment vehicles,
such as a vehicle that relies on an exclusion from the definition of
``investment company'' in section 3 of the Investment Company Act other
than section 3(c)(1) or 3(c)(7) of that Act? For example, should we
require advisers to provide quarterly statements to investors in pooled
investment vehicles that rely on the exclusion from the definition of
``investment company'' in section 3(c)(5)(C) of that Act? \20\
---------------------------------------------------------------------------

    \20\ Section 3(c)(5)(C) of the Investment Company Act provides
an exclusion from the definition of investment company for any
person who is not engaged in the business of issuing redeemable
securities, face-amount certificates of the installment type or
periodic payment plan certificates, and who is primarily engaged in
the business of purchasing or otherwise acquiring mortgages and
other liens on and interests in real estate.
---------------------------------------------------------------------------

     The proposed rule would require an adviser to distribute
the quarterly statement to the private fund's investors within 45 days
after each calendar quarter end, unless such a quarterly statement is
prepared and distributed by another person. Would this provision
eliminate burdens where there are multiple advisers to the same fund,
while still providing the fund's investors with the benefits of the
quarterly statement? Would the fund's primary adviser typically prepare
and distribute the quarterly statement in these circumstances? How
would advisers that do not prepare and distribute a quarterly statement
in reliance on another adviser demonstrate compliance with this
requirement?
     The proposed rule would require advisers to prepare and
distribute a quarterly statement disclosing certain information
regarding a private fund's fees, expenses, and performance. Are there
alternative approaches we should require to improve investor protection
and bring greater efficiencies to the market? For example, should we
establish maximum fees that advisers may charge at the fund level?
Should we prohibit certain compensation arrangements, such as the ``2
and 20'' model? Should we prohibit advisers from receiving compensation
from portfolio investments to the extent they also receive management
fees from the fund? Should we require advisers to disclose their
anticipated management fee revenue and operating budget to private fund
investors or an LPAC or other similar body (despite the limitations of
private fund governance mechanisms, as discussed above) on an annual or
more frequent basis? Should we impose limitations on management fees
(which are typically paid regardless of whether the fund generates a
profit), but not impose limitations on performance-based compensation
(which is typically tied to the success of the fund)? Should we
prohibit

management fees from being charged as a percentage of committed capital
and instead only permit management fees to be based on invested
capital, net asset value, and other similar types of fee bases? Should
we prohibit certain expense practices or arrangements, such as expense
caps provided to certain, but not all, investors?
     Similarly, should we prohibit certain types of private
fund performance information in the quarterly statement? For example,
should we prohibit advisers from presenting performance with the impact
of fund-level subscription facilities? Should we prohibit advisers from
presenting combined performance for multiple funds, such as a main fund
and a co-investment fund that pays lower or no fees?
     Do private fund advisers or their related persons receive
other economic benefits that the rule should require advisers to
disclose in the quarterly statement? For example, should the quarterly
statement also require disclosure and quantification of the kinds of
economic benefits commonly received by advisers or their related
persons from broker-dealers or other service providers to private
funds, such as hedge funds? Why or why not?
1. Fee and Expense Disclosure
    The proposed rule would require an investment adviser that is
registered or required to be registered to prepare and distribute
quarterly statements with certain information regarding fees and
expenses, including fees and expenses paid by underlying portfolio
investments to the adviser or its related persons. While the types of
fees and expenses charged to private funds can vary across the
industry, private funds are often more expensive than other asset
classes because the scope and magnitude of fees and expenses paid
directly and indirectly by private fund investors can be extensive.
Investors typically compensate the adviser for managing the affairs of
the fund, often in the form of management fees.\21\ On top of that,
investors typically pay or otherwise bear performance-based
compensation.\22\ A fund's portfolio investments also may pay fees to
the adviser or its related persons. For example, principals of the
adviser may receive cash or non-cash compensation--such as equity
awards or stock options--for serving as directors of a portfolio
investment owned by the private fund. Portfolio investment compensation
is typically in addition to compensation paid or allocated to the
adviser or its related persons at the fund level, unless the fund's
governing documents require the adviser to offset portfolio investment
compensation against other revenue streams or otherwise provide a
rebate to investors. Compensation at the ``portfolio investment-level''
is more common for certain private funds--such as private equity funds
or real estate funds--and less common for others--such as hedge funds.
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    \21\ Certain private fund advisers utilize a pass-through
expense model where the private fund pays for most, if not all,
expenses, including the adviser's expenses, but the adviser does not
charge a management fee. See infra section II.D.2. for a discussion
of such pass-through expense models.
    \22\ Investors typically enter into agreements under which the
private fund pays such compensation directly to the adviser or its
affiliates. Investors generally bear such compensation indirectly
through their investment in the private fund; however, certain
agreements may require investors to pay the adviser directly.
---------------------------------------------------------------------------

    Investors generally are required to bear all expenses related to
the operation of the fund and its portfolio investments. In addition to
expenses such as organizational and offering expenses, private fund
investors also frequently bear expenses that vary based on the private
fund's strategy and contractual agreements. For example, hedge fund
investors indirectly bear trading expenses. Investors in private equity
and venture capital funds indirectly bear expenses associated with fund
investments, such as deal sourcing and due diligence expenses,
including for investments that are unconsummated. Investors in private
funds with a real estate investment strategy also indirectly bear
expenses related to property management, environmental reviews, and
site inspections. These expenses generally are uncapped, and, unlike a
fund's performance-based compensation, private fund investors are
typically required to bear them regardless of whether the fund or the
applicable investment generates a positive return for investors.
    Investors often lack transparency regarding the total cost of such
fees and expenses.\23\ For example, even though investors indirectly
bear the costs associated with a portfolio investment paying fees to
the adviser or its related persons, advisers often do not disclose the
magnitude or scope of these fees to investors. Opaque reporting
practices make it difficult for investors to measure and evaluate
performance accurately and to make informed investment decisions.\24\
Moreover, such reporting practices may prevent private fund investors
from assessing whether the type and amount of fees and expenses borne
by the private fund comply with the fund's governing agreements and can
lead to problematic compensation schemes and sales practices with
investors bearing excess or improper fees and expenses. The Commission
has brought enforcement actions related to the disclosure and
allocation of fees and expenses by private fund advisers. For example,
we have alleged in settled enforcement actions that advisers have
received undisclosed fees,\25\ improperly shifted expenses away from
the adviser,\26\ and misallocated fees and expenses among private fund
clients.\27\ Staff has observed similarly problematic compensation
schemes and sales practices in its examinations of private fund
advisers.\28\ For example, staff has observed advisers that charge
private funds for expenses not permitted under the fund documents.
Staff has also observed advisers improperly allocate shared expenses,
such as broken-deal, due diligence, and consultant expenses, among
private fund clients and their own accounts.
---------------------------------------------------------------------------

    \23\ See Hedge Fund Transparency: Cutting Through the Black Box,
The Hedge Fund Journal, James R. Hedges IV (Oct. 2006) (stating that
``the biggest challenges facing today's hedge fund industry may well
be the issues of transparency and disclosure''), available at
https://thehedgefundjournal.com/hedge-fund-transparency/; Fees &
Expenses, Private Funds CFO (Nov. 2020) at 12 (noting that it is
becoming increasingly complicated for investors to determine what
the management fee covers versus what is a partnership expense and
stating that the ``formulas for management fees are complex and
unique to different investors.''), available at https://www.troutman.com/images/content/2/6/269858/PFCFO-FeesExpenses-Nov20-Final.pdf.
    \24\ See, e.g., Letter from State Treasurers and Comptrollers to
Mary Jo White, U.S. Securities & Exchange Commission (July 21,
2015), available at http://comptroller.nyc.gov/wp-content/uploads/documents/SEC_SignOnPDF.pdf; see also Letter from Americans for
Financial Reform Education Fund to Chairman Gary Gensler, U.S.
Securities & Exch. Commission (July 6, 2021), available at https://ourfinancialsecurity.org/wp-content/uploads/2021/07/Letter-to-SEC-re_-Private-Equity-7.6.21.pdf .
    \25\ See, e.g., In the Matter of Blackstone Management Partners,
L.L.C., et. al., Investment Advisers Act Release No. 4219 (Oct. 7,
2015) (settled action).
    \26\ See, e.g., In the Matter of Cherokee Investment Partners,
LLC and Cherokee Advisers, LLC, Investment Advisers Act Release No.
4258 (Nov. 5, 2015) (settled action).
    \27\ See, e.g., In the Matter of Lincolnshire Management, Inc.,
Investment Advisers Act Release No. 3927 (Sept. 22, 2014) (settled
action).
    \28\ See EXAMS Private Funds Risk Alert 2020, supra footnote 9.
---------------------------------------------------------------------------

    We have seen a significant increase in investors seeking
transparency regarding fees and expenses. For example, certain
investors and industry groups have encouraged advisers to adopt uniform
reporting templates to promote transparency and alignment of interests
between advisers and

investors.\29\ Despite these efforts, many advisers still do not
voluntarily provide adequate disclosure to investors. The proposed
quarterly statement rule would mandate them to provide it.
---------------------------------------------------------------------------

    \29\ See, e.g., Institutional Limited Partners Association
(``ILPA'') Reporting Template, available at https://ilpa.org/reporting-template/(stating that, since its release, more than one
hundred and forty organizations have endorsed the ILPA reporting
template, including more than twenty advisers).
---------------------------------------------------------------------------

a. Private Fund-Level Disclosure
    The proposed quarterly statement rule would require private fund
advisers to disclose the following information to investors in a table
format:
    (1) A detailed accounting of all compensation, fees, and other
amounts allocated or paid to the adviser or any of its related persons
by the private fund during the reporting period (``adviser
compensation'');
    (2) A detailed accounting of all fees and expenses paid by the
private fund during the reporting period other than those listed in
paragraph (1) above (``fund expenses''); and
    (3) The amount of any offsets or rebates carried forward during the
reporting period to subsequent quarterly periods to reduce future
payments or allocations to the adviser or its related persons.\30\
---------------------------------------------------------------------------

    \30\ Proposed rule 211(h)(1)-2(b).
---------------------------------------------------------------------------

    The table would provide investors with comprehensive fee and
expense disclosure for the prior quarterly period (or, in the case of a
newly formed private fund's initial quarterly statement, its first two
full calendar quarters of operating results).\31\ We will discuss each
of these elements in turn.
---------------------------------------------------------------------------

    \31\ See proposed rule 211(h)(1)-1 (defining ``reporting
period'' as the private fund's calendar quarter covered by the
quarterly statement or, for the initial quarterly statement of a
newly formed private fund, the period covering the private fund's
first two full calendar quarters of operating results). To the
extent a newly formed private fund begins generating operating
results on a day other than the first day of a calendar quarter
(e.g., January 1), the adviser should include such partial quarter
and the immediately succeeding calendar quarters in the newly formed
private fund's initial quarterly statement. For example, if a fund
begins generating operating results on February 1, the reporting
period for the initial quarterly statement would cover the period
beginning on February 1 and ending on September 30.
---------------------------------------------------------------------------

    Adviser Compensation. The proposed rule would require the fund
table to show a detailed accounting of all adviser compensation during
the reporting period, with separate line items for each category of
allocation or payment reflecting the total dollar amount.\32\ The
proposed rule is designed to capture all compensation, fees, and other
amounts allocated or paid to the investment adviser or any of its
related persons by the fund, including, but not limited to, management,
advisory, sub-advisory, or similar fees or payments, and performance-
based compensation.\33\
---------------------------------------------------------------------------

    \32\ Proposed rule 211(h)(1)-2(b)(1).
    \33\ We propose to define ``performance-based compensation'' as
allocations, payments, or distributions of capital based on the
private fund's (or its portfolio investments') capital gains and/or
capital appreciation. This definition's scope is broad and includes
cash or non-cash compensation, including, for example, in-kind
allocations, payments, or distributions of performance-based
compensation. We believe that the broad scope of the definition,
which would capture, without limitation, carried interest, incentive
fees, incentive allocations, or profit allocations, among other
forms of compensation, is appropriate given the various forms and
types of performance-based compensation across the private funds
industry.
---------------------------------------------------------------------------

    We believe requiring advisers to disclose all forms of adviser
compensation as separate line items (without prescribing particular
categories of fees) is appropriate because it would encompass the
various forms of adviser compensation across the private funds
industry. Many private funds compensate advisers with a ``2 and 20''
arrangement, consisting of a 2% management fee and a 20% share of any
profits generated by the fund. Certain advisers, however, receive other
forms of compensation from private funds in addition to, or in lieu of,
such amounts. For example, certain advisers charge private funds
administration fees or servicing fees. The proposal would help ensure
disclosure of the various forms of adviser compensation, and the
corresponding dollar amounts of each type of compensation, to current
investors regardless of how an adviser characterizes the compensation
and regardless of the different economic arrangements in place. This
would allow investors to understand and assess the magnitude and scope
of adviser compensation better and help validate that adviser
compensation conforms to contractual agreements.
    In addition to compensation paid to the adviser, the proposed rule
would require disclosure of compensation, fees, and other amounts
allocated or paid to the adviser's ``related persons.'' We propose to
define ``related persons'' to include: (i) All officers, partners, or
directors (or any person performing similar functions) of the adviser;
(ii) all persons directly or indirectly controlling or controlled by
the adviser; (iii) all current employees (other than employees
performing only clerical, administrative, support or similar functions)
of the adviser; and (iv) any person under common control with the
adviser.\34\ The term ``control'' would be defined to mean the power,
directly or indirectly, to direct the management or policies of a
person, whether through ownership of securities, by contract, or
otherwise.\35\
---------------------------------------------------------------------------

    \34\ Proposed rule 211(h)(1)-1. Form ADV also uses the same
definition. The regulations at 17 CFR 275.206(4)-2 (rule 206(4)-2)
use a similar definition by defining related person to include any
person, directly or indirectly, controlling or controlled by the
adviser, and any person that is under common control with the
adviser.
    \35\ Proposed rule 211(h)(1)-1. The definition, in addition,
provides that (i) each of an investment adviser's officers,
partners, or directors exercising executive responsibility (or
persons having similar status or functions) is presumed to control
the investment adviser; (ii) a person is presumed to control a
corporation if the person: (A) Directly or indirectly has the right
to vote 25% or more of a class of the corporation's voting
securities; or (B) has the power to sell or direct the sale of 25%
or more of a class of the corporation's voting securities; (iii) a
person is presumed to control a partnership if the person has the
right to receive upon dissolution, or has contributed, 25% or more
of the capital of the partnership; (iv) a person is presumed to
control a limited liability company if the person: (A) Directly or
indirectly has the right to vote 25% or more of a class of the
interests of the limited liability company; (B) has the right to
receive upon dissolution, or has contributed, 25% or more of the
capital of the limited liability company; or (C) is an elected
manager of the limited liability company; or (v) a person is
presumed to control a trust if the person is a trustee or managing
agent of the trust. Form ADV also uses the same definition.
---------------------------------------------------------------------------

    Many advisers conduct a single advisory business through multiple
separate legal entities or provide services to a private fund through
different affiliated entities. The proposed ``related person''
definition is designed to capture the various entities and personnel an
adviser may use to provide advisory services to, and receive
compensation from, private fund clients. We considered, but are not
proposing, a broader definition of related persons to include
additional entities related to the adviser or its personnel, such as
entities the adviser or its personnel own a financial interest in but
do not control. We are not proposing a broader definition because it
would likely capture entities or persons outside of the ones advisers
typically use to conduct a single advisory business. In addition, the
proposed definition is consistent with the definition of related person
used on Form ADV, which advisers have experience assessing as part of
their disclosure obligations on that form. We believe that the proposed
definition captures the relevant entities without being overly broad.
    Fund Fees and Expenses. The proposed rule would also require the
fund table to show a detailed accounting of all fees and expenses paid
by the private fund during the reporting period, other than those
disclosed as adviser compensation, with separate line items for each
category of fee or

expense reflecting the total dollar amount.\36\ Similar to the approach
taken with respect to adviser compensation discussed above, the
proposed rule would capture all fund fees and expenses paid during the
reporting period including, but not limited to, organizational,
accounting, legal, administration, audit, tax, due diligence, and
travel expenses.
---------------------------------------------------------------------------

    \36\ Proposed rule 211(h)(1)-2(b)(2).
---------------------------------------------------------------------------

    We have observed two general trends in the private funds industry
that support this approach. First, fund expenses have risen
significantly in recent years for certain private funds due to, among
other things, complex fund structures, global marketing and investment
efforts, and increased service provider costs.\37\ Advisers often pass
on such increases to the private funds they advise, without providing
investors with detailed disclosure about the magnitude or type of
expenses actually charged to the fund. Second, certain advisers have
shifted expenses related to their advisory business to private fund
clients.\38\ For example, some advisers charge private fund clients for
salaries and benefits related to personnel of the adviser. Such
expenses historically have been paid by advisers with management fee
proceeds or other revenue streams, but are increasingly being charged
as separate expenses that may not be transparent to fund investors.\39\
---------------------------------------------------------------------------

    \37\ See, e.g., Coming to Terms: Private Equity Investors Face
Rising Costs, Extra Fees (Dec. 20, 2021), available at https://
www.wsj.com/articles/coming-to-terms-private-equity-investors-face-
rising-costs-extra-fees-
11640001604#:~:text=Coming%20to%20Terms%3A%20Private-
Equity%20Investors%20Face%20Rising%20Costs%2C,and%20some%20expenses%2
0are%20excluded%20from%20annual%20fees.; Key Findings ILPA Industry
Intelligence Report ``What is Market in Fund Terms?'' (2021) (``ILPA
Key Findings Report''), available at https://ilpa.org/wp-content/uploads/2021/10/Key-Findings-Industry-Intelligence-Report-Fund-Terms.pdf.
    \38\ Such practice is often not disclosed, or not fully
disclosed, in private fund documents.
    \39\ See ILPA Key Findings Report, supra footnote 37.
---------------------------------------------------------------------------

    The proposed quarterly statement rule would require a detailed
accounting of each category of fund expense. This would require
advisers to list each specific category of expense as a separate line
item, rather than permit advisers to group fund expenses into broad
categories. For example, if a fund paid insurance premiums,
administrator expenses, and audit fees during the reporting period, a
general reference to ``fund expenses'' on the quarterly statement would
not satisfy the detailed accounting requirement. Instead, an adviser
would be required to list each specific category of expense (i.e.,
insurance premiums, administrator expenses, and audit fees), and the
corresponding dollar amount, separately. As with adviser compensation,
we believe this approach would provide private fund investors with
sufficient detail to validate that the fund expenses borne by the fund
conform to contractual agreements.
    To the extent a fund expense also could be characterized as adviser
compensation under the proposed rule, the proposed rule would require
advisers to disclose such payment or allocation as adviser compensation
and not as a fund expense in the quarterly statement. For example,
certain private funds may engage the adviser or its related persons to
provide services to the fund, such as consulting, legal, or back-office
services. An adviser would disclose any compensation, fees, or other
amounts allocated or paid by the fund for such services as part of the
detailed accounting of adviser compensation. This approach would help
ensure that investors understand the entire amount of adviser
compensation allocated or paid to the adviser and its related persons
during the reporting period.
    Offsets, Rebates, and Waivers. We are proposing to require advisers
to disclose adviser compensation and fund expenses in the fund table
both before and after the application of any offsets, rebates, or
waivers.\40\ Specifically, the proposed rule would require an adviser
to present the dollar amount of each category of adviser compensation
or fund expense before and after any such reduction for the reporting
period.
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    \40\ Proposed rule 211(h)(1)-2(b).
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    Advisers may offset, rebate, or waive adviser compensation or fund
expenses in a number of circumstances. For example, a private equity
adviser may enter into a management services agreement with a fund's
portfolio company, requiring the company to pay the adviser a fee for
those services. To the extent the fund's governing agreement requires
the adviser to share the fee with the fund investors through an offset
to the management fee, the management fee would typically be reduced,
on a dollar-for-dollar basis, by an amount equal to the fee.\41\ Under
the proposed rule, the adviser would be required to list the management
fee both before and after the application of the fee offset.\42\
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    \41\ The offset shifts some or all of the economic benefit of
the fee from the adviser to the private fund investors.
    \42\ Offsets, rebates, and waivers applicable to certain, but
not all, investors through one or more separate arrangements would
be required to be reflected and described prominently in the fund-
wide numbers presented in the quarterly statement. See proposed rule
211(h)(1)-2(d) and (g).
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    We considered whether to require advisers to disclose adviser
compensation and fund expenses only after the application of offsets,
rebates, and waivers, rather than before and after. We recognize that
investors may find the reduced numbers more meaningful, given that they
generally reflect the actual amounts borne by the fund during the
reporting period. We believe, however, that presenting both figures
would provide investors with greater transparency into advisers' fee
and expense practices, particularly with respect to how offsets,
rebates, and waivers affect adviser compensation. Transparency into fee
and expense practices is important because it would assist investors in
monitoring their private fund investments and, for certain investors,
would ease their own efforts at complying with their reporting
obligations.\43\ We also believe that advisers would have this
information readily available and both sets of figures would be helpful
to investors in monitoring whether and how offsets, rebates, and
waivers are applied.
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    \43\ For example, certain investors, such as U.S. state pension
plans, may be required to report complete information regarding fees
and expenses paid to the adviser and its related persons.
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    In addition, we are proposing to require advisers to disclose the
amount of any offsets or rebates carried forward during the reporting
period to subsequent periods to reduce future adviser compensation.\44\
This information would allow investors to understand whether they are
or the fund is entitled to additional reductions in future periods.\45\
Further, we believe that this information would assist investors with
their liquidity management and cash flow models, as they would have
greater insight into the fund's projected cash flows and their
obligations to satisfy future capital calls for adviser compensation
with cash on hand.
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    \44\ Proposed rule 211(h)(1)-2(b)(3).
    \45\ To the extent advisers are required to offset fund-level
compensation (e.g., management fees) by portfolio investment
compensation (e.g., monitoring fees), they typically do not reduce
adviser compensation below zero, meaning that, in the event the
monitoring fee offset amount exceeds the management fee for the
applicable period, some fund documents provide for ``carryforwards''
of the unused amount. The carryforwards are used to offset the
management fee in subsequent periods.
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    We request comment on all aspects of the proposed content of the
fund fee and expense table, including the following items:
     Should we require advisers to disclose all compensation
and fund expenses as proposed? Do commenters

agree with the scope of the proposal? Why or why not?
     Would the proposed content result in fund-level fee and
expense disclosure that is meaningful to investors? Are there other
items that advisers should be required to disclose in the fund table?
Are there any proposed items that we should eliminate? Would more or
less information about the fees and expenses charged to the fund be
helpful for investors? Are there any revisions to the descriptions of
fees that would make the proposed disclosure more useful to investors?
     Instead of the proposed approach, should we prescribe a
template for the fund table? Would the increased comparability of a
template be useful to investors? Would a template be flexible enough to
accommodate changes in the types of fees and expenses as well as the
types of offsets, rebates, or waivers used by private fund advisers?
Would a template necessitate repeated updating as the industry evolves?
     Should we include any additional definitions of terms or
phrases for the fund table? Should we omit any definitions we have
proposed for the fund table?
     The proposed rule would require an adviser to include the
compensation paid to a related person sub-adviser in its quarterly
statement. For private funds that have sub-advisers that are not
related persons, should we require a single quarterly statement showing
all adviser compensation (at both the adviser and sub-adviser levels)?
In cases where a non-related person sub-adviser does not prepare a
quarterly account statement in reliance on the adviser's preparation
and distribution of the quarterly statement to the fund's investors,
how would advisers reflect the compensation paid to the sub-adviser and
its related persons? Do commenters agree that such compensation would
be captured as a fund expense? Should we require a separate table
covering these fees and expenses, as well as a separate table showing
portfolio investment compensation paid to the sub-adviser or its
related person? How would advisers operationalize this requirement in
these circumstances?
     Should we adopt the proposed definitions of ``related
persons'' and ``control'' as proposed? Are they too broad? Are the
proposed definitions broad enough? Should we add former personnel of
the adviser or its related persons to the proposed definition? If so,
for how long after a departure from the adviser or its related persons
should such personnel fall into the definition? Should the definition
of related person include family members of adviser personnel or
persons who share the same household with adviser personnel? Should the
definition capture any person directly or indirectly controlled by the
adviser's officers, partners, or directors (including any consulting
firms controlled by such persons)? Should it capture operational
partners, senior advisors, or other similar consultants of the adviser,
the private fund, or its portfolio investments? Should we add any
entity more than five percent of the ownership of which is held,
directly or indirectly, by the adviser or its personnel? Should the
definition include any person that receives, directly or indirectly,
management fees or performance based compensation from, or in respect
of, the fund; or any person that has an interest in the investment
adviser or general partner (or similar control person) of the fund? If
we adopt a different definition of ``related person'' than what is
being proposed, should we use a different defined term (such as
``related party'') to avoid confusion given that the term ``related
person'' is defined in Form ADV?
     For purposes of the definition of ``control,'' are the
control presumptions appropriate in this context? Should we eliminate
or modify any of the presumptions? For example, should we eliminate
aspects of the definition that may capture passive investors who do not
have the power to direct the management or policies of the relevant
entity? Why or why not? Should we add any additional control
presumptions? For example, should an entity be presumed to be
controlled by an adviser to the extent the adviser has authority over
the entity's budget or whether to hire personnel or terminate their
employment?
     The proposed rule includes a non-exhaustive list of
certain types of adviser compensation and fund expenses.\46\ Would this
information assist advisers in complying with the rule? Should we add
any additional types? If so, which ones and why?
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    \46\ Proposed rule 211(h)(1)-2(b)(1) includes the following non-
exhaustive list of adviser compensation: Management, advisory, sub-
advisory, or similar fees or payments, and performance-based
compensation. Proposed rule 211(h)(1)-2(b)(2) includes the following
non-exhaustive list of fund expenses: Organizational, accounting,
legal, administration, audit, tax, due diligence, and travel fees
and expenses.
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     Do private fund advisers or their related persons receive
other economic benefits that the rule should require advisers to
disclose in the quarterly statement? For example, should we require
hedge fund advisers to disclose the dollar amount of any soft dollar or
similar benefits provided by broker-dealers that execute trades for the
funds, or any benefits provided by hedge fund prime brokers?
     Do commenters agree with the scope of the proposed
definition of ``performance-based compensation''? Should we specify the
types of compensation that should be included in the definition? For
example, should the definition specify that the term includes carried
interest, incentive fees, incentive allocations, performance fees, or
profit allocations?
     Should we only require the table to disclose adviser
compensation and fund expenses after the application of any offsets,
rebates, or waivers, rather than before and after, as proposed? If so,
why?
     Should we define offsets, rebates, and waivers? If so,
what definitions should we use and why? Are there any types of offsets,
rebates, and waivers that we should not require advisers to reflect in
the fund table? If so, which ones and why? To the extent that offsets,
rebates, or waivers are available to certain, but not all, investors,
are there any operational concerns with reflecting and describing those
offsets, rebates, or waivers in the fund-wide numbers presented in the
quarterly statement? Are there alternatives we should use?
     Should we require advisers to disclose the amount of any
offsets or rebates carried forward during the reporting period to
subsequent periods to reduce future adviser compensation as proposed?
Would this information be helpful for investors? Do advisers already
provide this information in the fund's financial statements or
otherwise?
     Should we require advisers to provide any additional
disclosures regarding fees and expenses in the quarterly statement? In
particular, should we require any disclosures from an investment
adviser's Form ADV Part 2A narrative brochure (if applicable) to be
included in the quarterly statement, such as more details about an
investment adviser's fees?
     Should we tailor the disclosure requirements based on fund
type? For example, should the requirements or format for hedge funds
differ from the requirements and format for private equity funds? Are
there unique fees or expenses for types of funds that advisers should
be required to disclose or otherwise list as a separate line item? If
so, how should we define these types of funds for these purposes? For
example, should we use the definitions of such terms used on Form ADV?

     Do any of the proposed requirements impose unnecessary
costs or compliance challenges? Please provide specific data. Are there
any modifications to the proposal that we could make that would lower
those costs or mitigate those challenges? Please provide examples.
     The proposed quarterly statement prescribes minimum fee
and expense information that must be included. What are the benefits
and drawbacks of prescribing the minimum disclosure to be included in
the quarterly statement and otherwise permitting advisers to include
additional information? Do commenters agree that we should allow
advisers to include additional information? Would the inclusion of
additional information affect whether investors review the quarterly
statement?
     Certain advisers use management fee waivers where the
amount of management fees paid by the fund to the adviser is reduced in
exchange for an increased interest in fund profits.\47\ Because fund
agreements often document such waivers with complex and highly
technical tax provisions, should we provide guidance to assist advisers
in complying with the proposed requirement to describe the manner in
which they are calculated or specify a methodology for such
calculations?
---------------------------------------------------------------------------

    \47\ Management fee waiver arrangements often provide certain
economic benefits for the adviser, such as the possibility of
reducing and/or deferring certain tax obligations.
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     Should we permit advisers to exclude expenses from the
quarterly statement if they are below a certain threshold?
Alternatively, should we permit advisers to group expenses into broad
categories and disclose them under single line item--such as
``Miscellaneous Expenses'' or ``Other Expenses''--if the aggregate
amount is de minimis relative to the fund's size? Why or why not?
     The proposed rule would require the initial quarterly
statement for newly formed funds to include start-up and organizational
fees of the fund if they were paid during the reporting period.
Instead, should the proposed rule exclude those fees and expenses?
     Should the table provide fee and expense information for
any other periods? For example, should we require advisers to disclose
all adviser compensation and fund expenses since inception (in addition
to adviser compensation and fund expenses allocated or paid during the
applicable reporting period)? If so, should we require since-inception
information only for certain types of funds, such as closed-end private
funds, and not for other types of funds, such as open-end private
funds?
     We recognize that certain private fund advisers may
already provide quarterly account or similar statements to investors,
such as advisers that rely on an exemption from certain disclosure and
recordkeeping requirements provided by U.S. Commodity Futures Trading
Commission regulations at 17 CFR 4.7. How often are private fund
advisers separately required to provide such quarterly statements, and
how often do they do so even when not required? Would there be any
overlap between the proposed quarterly statement and the existing
quarterly account or similar statements currently prepared by advisers?
b. Portfolio Investment-Level Disclosure
    The proposed quarterly statement rule would require advisers to
disclose the following information with respect to any covered
portfolio investment,\48\ in a single table covering all such covered
portfolio investments:
---------------------------------------------------------------------------

    \48\ See proposed rule 211(h)(1)-1 (defining ``covered portfolio
investment'' as a portfolio investment that allocated or paid the
investment adviser or its related persons portfolio investment
compensation during the reporting period).
---------------------------------------------------------------------------

    (1) A detailed accounting of all portfolio investment compensation
allocated or paid by each covered portfolio investment during the
reporting period; \49\ and
---------------------------------------------------------------------------

    \49\ See proposed rule 211(h)(1)-1 (defining ``portfolio
investment compensation'' as any compensation, fees, and other
amounts allocated or paid to the investment adviser or any of its
related persons by the portfolio investment attributable to the
private fund's interest in such portfolio investment).
---------------------------------------------------------------------------

    (2) The private fund's ownership percentage of each such covered
portfolio investment as of the end of the reporting period or, if the
fund does not have an ownership interest in the covered portfolio
investment, the adviser would be required to list zero percent as the
fund's ownership percentage along with a brief description of the
fund's investment in such covered portfolio investment.\50\
---------------------------------------------------------------------------

    \50\ Proposed rule 211(h)(1)-2(c).
---------------------------------------------------------------------------

    The proposed rule defines ``portfolio investment'' as any entity or
issuer in which the private fund has invested directly or
indirectly.\51\ This definition is designed to capture any entity or
issuer in which the private fund holds an investment including through
holding companies, subsidiaries, acquisition vehicles, special purpose
vehicles, and other vehicles through which investments are made or
otherwise held by the private fund.\52\ As a result, the proposed
definition may capture more than one entity or issuer with respect to
any single investment made by a private fund. For example, if a private
fund invests directly in a holding company that owns two subsidiaries,
the proposed definition would capture all three entities. Depending on
a private fund's underlying investment structure, an adviser may have
to determine, in good faith, which entity or entities constitute the
portfolio investment under the proposed rule.
---------------------------------------------------------------------------

    \51\ Proposed rule 211(h)(1)-1.
    \52\ Certain investment strategies can involve complex
transactions and the use of negotiated instruments or contracts,
such as derivatives, with counterparties. Although such trading
involves a risk that a counterparty will not settle a transaction or
otherwise fail to perform its obligations under the instrument or
contract and thus result in losses to the fund, we would generally
not consider the fund to have made an investment in the counterparty
in this context. We believe this approach is appropriate because any
gain or loss from the investment generally would be tied to the
performance of the derivative and the underlying reference security,
rather than the performance of the counterparty.
---------------------------------------------------------------------------

    We considered, but are not proposing, using the term ``portfolio
company,'' rather than ``portfolio investment.'' We believe that the
term ``portfolio company'' would be too narrow given that some private
funds do not invest in traditional operating companies. For example,
certain private funds originate loans and invest in credit-related
instruments, while others invest in more bespoke assets such as music
royalties, aircraft, and tanker vessels. The proposed rule would define
``portfolio investment'' to apply to all types of private fund
investments and structures. The proposed definition also is designed to
remain evergreen, capturing new investment structures as they continue
to evolve.
    We recognize, however, that portfolio investments of certain
private funds may not pay or allocate portfolio-investment compensation
to an adviser or its related persons. For example, advisers to hedge
funds focusing on passive investments in public companies may be less
likely to receive portfolio-investment compensation than advisers to
private equity funds focusing on control-oriented investments in
private companies. Under the proposed rule, advisers would only be
required to disclose information regarding covered portfolio
investments, which we propose to define as portfolio investments that
allocated or paid the investment adviser or its related persons
portfolio investment compensation during the reporting period.\53\ We

believe this approach is appropriate because the portfolio investment
table is designed to highlight the scope and magnitude of any
investment-level compensation as well as to improve transparency for
investors into the potential conflicts of interest of the adviser and
its related persons. If an adviser does not receive such compensation,
we do not believe the adviser should have such a reporting obligation.
Accordingly, the proposed rule would not require advisers to list any
information regarding portfolio investments that do not fall within the
covered portfolio investment definition for the applicable reporting
period. These advisers, however, would need to identify portfolio
investment payments and allocations in order to know whether they must
provide the disclosures under this requirement.
---------------------------------------------------------------------------

    \53\ See proposed rule 211(h)(1)-1 (defining ``covered portfolio
investment'').
---------------------------------------------------------------------------

    Portfolio Investment Compensation. The proposed rule would require
the portfolio investment table to show a detailed accounting of all
portfolio investment compensation allocated or paid by each covered
portfolio investment during the reporting period, with separate line
items for each category of allocation of payment reflecting the total
dollar amount, including (though it is not limited to) origination,
management, consulting, monitoring, servicing, transaction,
administrative, advisory, closing, disposition, directors, trustees or
similar fees or payments by the covered portfolio investment to the
investment adviser or any of its related persons. An adviser should
disclose the identity of each covered portfolio investment to the
extent necessary for an investor to understand the nature of the
conflicts associated with such payments.
    Similar to the approach taken with respect to adviser compensation
and fund expenses discussed above, the proposed rule would require a
detailed accounting of all portfolio investment compensation paid or
allocated to the adviser and its related persons.\54\ This would
require advisers to list each specific type of portfolio investment
compensation, and the corresponding dollar amount, as a separate line
item. We believe that this approach is appropriate given that portfolio
investment compensation can take many different forms and often varies
based on fund type. For example, portfolio investments of private
credit funds may pay the adviser a servicing fee for managing a pool of
loans held directly or indirectly by the fund. Portfolio investments of
private real estate funds may pay the adviser a property management fee
or a mortgage-servicing fee for managing the real estate investments
held directly or indirectly by the fund.
---------------------------------------------------------------------------

    \54\ Because advisers often use separate legal entities to
conduct a single advisory business, the proposed rule would capture
portfolio investment compensation paid to an adviser's related
persons.
---------------------------------------------------------------------------

    We believe that this disclosure would inform investors about the
scope of portfolio investment compensation paid to the adviser and
related persons, and could help provide insight into some of the
conflicts of interest some advisers face. For example, in cases where
the adviser controls the portfolio investment, the adviser also
generally has discretion over whether to charge portfolio investment
compensation and, if so, the rate, timing, method, amount, and
recipient of such compensation. Additionally, where the private fund's
governing documents require the adviser to offset portfolio investment
compensation against other revenue streams or otherwise provide a
rebate to investors, this information would also help investors monitor
the application of such offsets or rebates.
    The proposed rule would require the adviser to disclose the amount
of portfolio investment compensation attributable to the private fund's
interest in the covered portfolio investment.\55\ Such amount would not
reflect the portion attributable to any other person's interest in the
covered portfolio investment. For example, if the private fund and
another person co-invested in the same portfolio investment and the
portfolio investment paid the private fund's adviser a monitoring fee,
the table would only list the total dollar amount of the monitoring fee
attributable to the fund's interest. We believe this approach is
appropriate because it would reflect the amount borne by the fund and,
by extension, the investors. This would be meaningful information for
investors because the amount attributable to the fund's interest
typically reduces the value of investors' indirect interest in the
portfolio investment.\56\ Subject to the requirements of the proposed
rule, advisers may, but are not required to, also list the portion of
the fee attributable to any other investor's interest in the portfolio
investment.
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    \55\ See proposed rule 211(h)(1)-1 (defining ``portfolio
investment compensation'').
    \56\ We believe that this information would be meaningful for
investors regardless of whether the private fund has an equity
ownership interest or another kind of interest in the covered
portfolio investment. For example, if a private fund's interest in a
covered portfolio investment is represented by a debt instrument,
the amount of portfolio-investment compensation paid or allocated to
the adviser may hinder or prevent the covered portfolio investment
from satisfying its obligations to the fund under the debt
instrument.
---------------------------------------------------------------------------

    Similar to the approach discussed above with respect to adviser
compensation and fund expenses, an adviser would be required to list
the amount of portfolio investment compensation allocated or paid with
respect to each covered portfolio investment both before and after the
application of any offsets, rebates, or waivers. This would require an
adviser to present the aggregate dollar amount attributable to the
fund's interest before and after any such reduction for the reporting
period. Advisers would be required to disclose the amount of any
portfolio investment compensation they initially charge and the amount
they ultimately retain at the expense of the private fund and its
investors. As with adviser compensation and fund expenses, we believe
this approach would provide investors with sufficient detail to
validate that portfolio investment compensation borne by the fund
conforms to contractual agreements.
    Ownership Percentage. The proposed rule would require the portfolio
investment table to list the fund's ownership percentage of each
covered portfolio investment that paid or allocated portfolio-
investment compensation to the adviser or its related persons during
the reporting period.\57\ The adviser would be required to determine
the fund's ownership percentage as of the end of the reporting period.
We believe that this information would provide investors with helpful
context of the amount of portfolio investment compensation paid or
allocated to the adviser or its related persons relative to the fund's
ownership. For example, portfolio investment compensation may be
calculated based on the portfolio investment's total enterprise value
or other similar metric. We believe that the fund's ownership
percentage would help private fund investors understand and assess the
magnitude of such compensation, as well as how it affects the value of
the fund's investment.
---------------------------------------------------------------------------

    \57\ Proposed rule 211(h)(1)-2(c)(2). An adviser should also
list zero percent as the ownership percentage if the fund has sold
or completely written off its ownership interest in the covered
portfolio investment during the reporting period.
---------------------------------------------------------------------------

    We recognize that calculating the fund's ownership percentage may
be difficult in certain circumstances, especially for funds that do not
make equity investments in operating companies. For example, a private
equity secondaries fund may own a preferred security or a hybrid
instrument that entitles the fund to

priority distributions until it receives a certain return on its
initial investment. A direct lending fund may provide a loan to a
company that entitles the fund to receive interest payments and a
return of principal. If the fund does not have an ownership interest in
the covered portfolio investment, such as when the fund holds a debt
instrument, the adviser would be required to list zero percent as the
fund's ownership percentage, along with a brief description of the
fund's investment in the portfolio investment table, if the covered
portfolio investment paid or allocated portfolio-investment
compensation to adviser or its related persons during the reporting
period.
    We request comment on all aspects of the proposed content of the
portfolio investment table, including the following items:
     Would the proposed rule provide portfolio investment
compensation disclosure that is meaningful to investors? Should the
rule require advisers to disclose additional or different information
in the portfolio-investment table? Would more information about the
fees and expenses charged to portfolio investments be helpful for
investors?
     Should we include any additional definitions of terms or
phrases for the portfolio-investment table? Should we omit any
definitions we have proposed for the portfolio-investment table?
     Is the proposed definition of ``portfolio investment''
clear? Should we modify or revise the proposed definition? For example,
should we define ``portfolio investment'' as any person whose
securities are beneficially owned by the private fund or any person in
which the private fund owns an equity or debt interest? Alternatively,
should we define ``portfolio investment'' as any underlying company,
business, platform, issuer, or other person in which the private fund
has made, directly or indirectly, an investment? Should we permit
advisers to determine, in good faith, which entity or entities
constitute the portfolio investment for purposes of the quarterly
statement rule? For example, a fund of funds may indirectly invest in
hundreds of issuers or entities. Depending on the underlying structure,
control relationship, and reporting, the fund of funds' adviser may
have limited knowledge regarding such underlying entities or issuers.
Should we exclude such entities or issuers from the definition of
portfolio investment for such advisers? Is there a different standard
or test we should use? Should we require such adviser to conduct a
reasonable amount of diligence consistent with past practice and/or
industry standards? Why or why not?
     As discussed above, to the extent a private fund enters
into a negotiated instrument, such as a derivative, with a
counterparty, we would not consider the private fund to have made an
investment in the counterparty. Do commenters agree with this approach?
Why or why not? Should we adopt a different approach for derivatives or
other similar instruments generally? For purposes of determining
whether the fund has made an investment in an issuer or entity, should
we only include equity investments? Should we exclude derivatives? Why
or why not? How should exchange-traded (i.e., not negotiated)
derivatives, including swaps and options, be treated for purposes of
the rule?
     The proposed definition of portfolio investment would not
distinguish among different types of private funds. Is our approach in
this respect appropriate or should we treat certain funds differently
depending on their strategy or fund type? If so, how should we reflect
that treatment? For example, should we modify the definition with
respect to a real estate fund to reflect that such a fund generally
invests in real estate assets, rather than operating companies? Because
a secondaries fund may indirectly invest in a significant number of
underlying operating companies or other assets, should we limit the
``indirect'' component of the definition for such funds (or any other
funds that may have indirect exposure to a significant number of
companies or assets)? Why or why not? Would additional definitions be
appropriate or useful? Should the proposed rule define the term
``entity'' and/or ``issuer''? If so, how? Should the proposed rule
treat hedge funds, liquidity funds, and other open-end private funds
differently than private equity funds and other closed-end private
funds?
     Should we adopt the approach with respect to portfolio-
investment compensation as proposed? Do commenters agree with the scope
of the proposal? Why or why not?
     The proposed rule includes non-exhaustive lists of certain
types of fees. Would this information assist advisers in complying with
the rule? Should we add any additional types? If so, which ones and
why?
     Should we require advisers to list each type of portfolio-
investment compensation as a separate line item as proposed? Would this
level of detail be helpful for investors with respect to portfolio-
investment reporting? Given that many funds require a management fee
offset of all portfolio-investment compensation, is this level of
detail necessary or useful to investors? Should we instead require
advisers to provide aggregate information for each covered portfolio
investment?
     Should the rule permit advisers to use project or deal
names or other codes, and if so, what additional disclosures are
necessary for an investor to understand the nature of the conflicts?
     We considered only requiring advisers to disclose the
amount of portfolio investment compensation after the application of
any offsets, rebates, or waivers, rather than before and after. We
believe the proposed approach would be more helpful for investors
because investors would have greater insight into the compensation
advisers initially charge and the amount they ultimately retain at the
expense of the private fund and its investors. Do commenters agree? Why
or why not?
     Would information about a firm's services to portfolio
investments be helpful for investors? Are there any elements of the
proposed requirements that firms should or should not include? If so,
which ones and why?
     We considered requiring advisers to disclose the total
portfolio-investment compensation for the reporting period as an
aggregate number, rather than providing the amount of compensation
allocated or paid by each covered portfolio investment as proposed.
However, we believe that investment-by-investment information would
provide investors with greater transparency into advisers' fee and
expense practices and thus be more helpful for investors. Do commenters
agree? Should we require advisers to report a consolidated ``top-line''
number that covers all covered portfolio investments?
     Should we define the term ``ownership interest''? If so,
how should we define it? For purposes of the rule, should a private
fund be deemed to hold an ``ownership interest'' in a covered portfolio
investment only to the extent the fund has made an equity investment in
the covered portfolio investment? Why or why not? What types of funds
may not hold an ``ownership interest'' in a covered portfolio
investment?
     The proposed rule would require advisers to list the
fund's ownership percentage of each covered portfolio investment.
Because the definition of ``portfolio investment'' could capture more
than one entity, will advisers be able to calculate the fund's
ownership percentage? Are there any changes to the proposed rule text
that could mitigate this challenge? If a portfolio investment captures
multiple entities,

should we require advisers to list the fund's overall ownership of such
entities? If so, what criteria should advisers use to determine a
fund's overall ownership?
     Should we require advisers to disclose how they allocate
or apportion portfolio-investment compensation among multiple private
funds invested in the same covered portfolio investment? If so, how
should the portfolio investment table reflect this information?
     Certain advisers have discretion or substantial influence
over whether to cause a fund's portfolio investment to compensate the
adviser or its related persons. Should the requirement to disclose
portfolio-investment compensation apply only to advisers that have such
discretion or authority? Should such requirement apply if the adviser
is entitled to appoint one or more directors to the portfolio
investment's board of directors or similar governing body (if
applicable)? Is there another standard we should require?
     We recognize that certain private funds, such as
quantitative and algorithmic funds and other similar funds, may have
thousands of holdings and/or transactions during a quarter and that
those funds typically do not receive portfolio investment compensation.
While the proposed rule would not require an adviser to include any
portfolio investment that did not pay or allocate portfolio-investment
compensation to the adviser or its related persons during the reporting
period in its quarterly statement, these advisers would need to
consider how to identify such portfolio investment's payments and
allocations for purposes of complying with this disclosure requirement.
Should the rule provide any full or partial exceptions for such funds?
Should we require investment-level disclosure for quantitative,
algorithmic, and other similar funds only where they own above a
specified threshold percentage of the portfolio investment? For
example, should such funds only be required to provide investment-level
disclosure where they own 25% or more ownership of any class of voting
shares? Alternatively, should we use a lower ownership threshold, such
as 20%, 10%, or 5%? Should we adopt a similar approach for all private
funds, rather than just quantitative, algorithmic, and other similar
funds? If so, what threshold should we apply? For instance, should it
be 5%? Or 10%? A higher percentage?
     Should we exclude certain types of private funds from
these disclosures? If so, which funds and how should we define them?
For example, should we exclude private funds that only hold (or
primarily hold) publicly traded securities, such as hedge funds?
     Should we require layered disclosure for the portfolio-
investment table (i.e., short summaries of certain information with
references and links to other disclosures where interested investors
can find more information)? Would this approach encourage investors to
ask questions and seek more information about the adviser's practices?
Are there modifications or alternatives we should impose to improve the
utility of the information for private fund investors, such as
requiring the quarterly statement to present information in a tabular
format?
     Are there particular funds that may require longer
quarterly statements than other funds? Please provide data regarding
the number of funds that have covered portfolio investments and, with
respect to those funds, the number of covered portfolio investments per
private fund. Should the Commission take into account the fact that
certain funds will have more covered portfolio investments than other
funds? For example, should we require funds that have more than a
specific number of covered portfolio investments, such as 50 or more
covered portfolio investments, to provide only portfolio-investment
level reporting for a subset of their covered portfolio investments,
such as a specific number of their largest holdings during the
reporting period (e.g., their largest ten, fifteen, or twenty
holdings)?
     The proposed rule would require advisers to list zero
percent as the ownership percentage if the fund has completely sold or
completely written off its ownership interest in the covered portfolio
investment during the reporting period. Instead, should we require or
permit advisers to exclude any such portfolio investments from the
table? Why or why not?
     The proposed rule would require the adviser to disclose
the amount of portfolio investment compensation attributable to the
private fund's interest in the covered portfolio investment that is
paid or allocated to the adviser and its related persons. Should we
require disclosure of portfolio compensation paid to other persons
(such as co-investors, joint venture partners, and other third parties)
to the extent such compensation reduces the value of the private fund's
interest in the portfolio investment?
c. Calculations and Cross References to Organizational and Offering
Documents
    The proposed quarterly statement rule would require each statement
to include prominent disclosure regarding the manner in which expenses,
payments, allocations, rebates, waivers, and offsets are
calculated.\58\ This would generally have the effect of requiring
advisers to describe, for example, the structure of, and the method
used to determine, any performance-based compensation set forth in the
statement (such as the distribution waterfall, if applicable) and the
criteria on which each type of compensation is based (e.g., whether
compensation is fixed, based on performance over a certain period, or
based on the value of the fund's assets). We believe that this
disclosure would assist private fund investors in understanding and
evaluating the adviser's calculations.
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    \58\ Proposed rule 211(h)(1)-2(d).
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    To facilitate an investor's ability to seek additional information,
the quarterly statement also must include cross references to the
relevant sections of the private fund's organizational and offering
documents that set forth the calculation methodology.\59\ References to
these disclosures would be valuable so that the investor can compare
what the private fund's documents state the fund (and indirectly the
investors) will be obligated to pay to what the fund (and indirectly
the investors) actually paid during the reporting period and more
easily determine the accuracy of the charges. For example, including
this information on the quarterly statement would likely enable an
investor to confirm that the adviser calculated advisory fees in
accordance with the fund's organizational and offering documents and to
identify whether the adviser deducted or charged incorrect or
unauthorized amounts. We believe this information also would allow the
investor to assess the effect those fees and costs have had on its
investment.
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    \59\ Id.
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    We request comment on the following aspects of the proposed rule:
     Should we allow flexibility in the words advisers use, as
proposed, or should we require advisers to include prescribed wording
in disclosing calculation methodology? If the latter, what prescribed
wording would be helpful for investors? Does the narrative style work
or are there other presentation formats that we should require?
     Should we provide additional guidance or specify
additional requirements regarding what type of

disclosure generally should or must be included to describe the manner
in which expenses, payments, allocations, rebates, waivers, and offsets
are calculated? For example, should we provide sample disclosures
describing various calculations? Should the rule require advisers to
restate disclosures from offering memoranda (if applicable) regarding
the manner in which expenses, payments, allocations, rebates, waivers,
and offsets are calculated in the quarterly statement? Do commenters
believe that advisers would prefer to restate offering memoranda
disclosures rather than drafting new disclosures to avoid conflicting
interpretations of potentially complex fund terms? Should the rule only
require advisers to provide a cross reference to the language in the
fund's governing documents regarding this information (e.g.,
identifying the relevant document and page or section numbers)?
     Would providing cross references, as proposed, to the
relevant sections of the private fund's organizational and offering
documents be helpful for investors? Would it permit investors to
``cross check'' or evaluate the adviser's calculations? Are there other
alternatives that would achieve our objectives?
2. Performance Disclosure
    In addition to providing information regarding fees and expenses,
the proposed rule would require an adviser to include standardized fund
performance information in each quarterly statement provided to fund
investors. The proposed rule would require an adviser to a liquid fund
(as defined below) to show performance based on net total return on an
annual basis since the fund's inception, over prescribed time periods,
and on a quarterly basis for the current year. For illiquid funds (also
defined below), the proposed rule would require an adviser to show
performance based on the internal rate of return and a multiple of
invested capital. The proposed rule would require an adviser to display
the different categories of required performance information with equal
prominence.\60\
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    \60\ Proposed rule 211(h)(1)-2(e)(2). For example, the proposed
rule would require an adviser to an illiquid fund to show gross
internal rate of return with the same prominence as net internal
rate of return. Similarly, the proposed rule would require an
adviser to a liquid fund to show the annual net total return for
each calendar year with the same prominence as the cumulative net
total return for the current calendar year as of the end of the most
recent calendar quarter covered by the quarterly statement.
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    It is essential that quarterly statements include performance in
order to enable investors to compare private fund investments and
comprehensively understand their existing investments and determine
what to do holistically with their overall investment portfolio. A
quarterly statement that includes fee, expense, and performance
information would allow investors to monitor for abnormalities and
better understand the impact of fees and expenses on their investments.
For example, a quarterly statement that includes fee and expense, but
not performance, information would not allow an investor to perform a
cost-benefit analysis to determine whether to retain the current
investment or consider other options or, for an investor in an illiquid
fund, to determine whether to invest in other private funds managed by
the same adviser. In addition, current clients or investors may use
fee, expense, and performance information about their current
investments to inform their overall investment decisions (e.g., whether
to diversify) and their view of the market.
    Although there are commonalities between the performance reporting
elements of the proposed rule and the performance elements of our
recently adopted marketing rule, the two rules satisfy somewhat
different policy goals. Our experience has led us to believe that,
while all clients and investors should be protected against misleading,
deceptive, and confusing information, as is the policy goal of the
marketing rule,\61\ the needs of current clients and investors often
differ in some respects from the needs of prospective clients and
investors, as detailed below. Current investors should receive
performance reporting that allows them to evaluate an investment
alongside corresponding fee and expense information. Current investors
also should receive performance reporting that is provided at timely,
predictable intervals so that an investor can monitor and evaluate its
investment progress over time, remain abreast of changes, compare
information from quarter to quarter, and take action where
possible.\62\
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    \61\ See Investment Adviser Marketing, Investment Advisers Act
Release No. 5653 (Dec. 22, 2021) (``Marketing Release''), at section
II.A.2.a.iv (noting that the definition of ``advertisement''
includes a communication to a current investor that offers new or
additional advisory services with regard to securities, provided
that the communication otherwise satisfies the definition of
``advertisement.'').
    \62\ The marketing rule and its specific protections would
generally not apply in the context of a quarterly statement. See
Marketing Release, supra footnote 61, at sections II.A.2.a.iv and
II.A.4. The compliance date for the Marketing Rule is November 4,
2022.
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    Currently, there are various approaches to report private fund
performance to fund investors, often depending on the type of private
fund (e.g., the fund's strategy, structure, target asset class,
investment horizon, or liquidity profile). Certain of these approaches
may be misleading without the benefit of well-disclosed assumptions,
and others may lead to investor confusion. For example, an adviser
showing internal rate of return with the impact of fund-level
subscription facilities could mislead investors because that method of
calculation would artificially increase performance metrics.\63\ An
adviser showing private fund performance as compared to a public market
equivalent (``PME'') in a case where the private fund does not have an
appropriate benchmark could mislead investors to believe that the
private fund performance will meet or exceed the performance of the
PME. Certain investors may also mistakenly believe that their private
fund investment has a liquidity profile that is similar to an
investment in the PME or an index that is similar to the PME.
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    \63\ See infra section II.A.2.b. (Performance Disclosure:
Illiquid Funds).
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    Without standardized performance metrics (and adequate disclosure
of the criteria used and assumptions made in calculating the
performance),\64\ investors cannot compare their various private fund
investments managed by the same adviser nor can they gauge the value of
an adviser's investment management services by comparing the
performance of private funds advised by different advisers.\65\
Standardized performance information would help an investor decide
whether to continue to invest in the private fund, if redemption is
possible, as well as more holistically to make decisions about other
components of the investor's portfolio. Furthermore, we believe that
proposing to require advisers to show performance information alongside
fee and expense information as part of the quarterly statement would
paint a more complete picture of an investor's private fund investment.
This would particularly provide context for investors that are

paying performance-based compensation and would help investors
understand the true cost of investing in the private fund. This
proposed performance reporting would also provide greater transparency
into how private fund performance is calculated, improving an
investor's ability to interpret performance results.\66\
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    \64\ Private funds can have various types of complicated
structures and involve complex financing mechanisms. As a result, an
adviser may need to make certain assumptions when calculating
performance for private funds, specifically illiquid funds.
    \65\ See David Snow, Private Equity: A Brief Overview: An
introduction to the fundamentals of an expanding, global industry,
PEI Media (2007), at 11 (discussing variations on private equity
performance metrics).
    \66\ Private fund investors increasingly request additional
disclosure regarding private fund performance, including
transparency into the calculation of the performance metrics. See,
e.g., GPs feel the strain as LPs push for more transparency on
portfolio performance and fee structures, Intertrust Group (July 6,
2020), available at https://www.intertrustgroup.com/news/gps-feel-the-strain-as-lps-push-for-more-transparency-on-portfolio-performance-and-fee-structures/; ILPA Principals 3.0, at 36
``Financial and Performance Reporting'' and ``Fund Marketing
Materials,'' available at https://ilpa.org/wp-content/flash/ILPA%20Principles%203.0/?page=36.