On February 6, 2024, the staff of the Securities and Exchange Commission (SEC) issued an updated FAQ with respect to the Marketing Rule (Rule 206(4)-1) under the Investment Advisers Act of 1940 (the Advisers Act). This FAQ takes two positions:
- A private fund sponsor cannot present gross internal rate of return (gross IRR) without the impact of fund borrowing (including subscription facilities) alongside only the net internal rate of return (net IRR) with the impact of such borrowing.
- It is a violation of the general prohibitions of the Marketing Rule to show net IRR with the impact of fund-level subscription facilities without either (a) showing comparable net IRR without the impact of fund-level subscription facilities or (b) providing appropriate disclosures describing the impact of such subscription facilities on the net IRR.
Private fund sponsors should review their performance presentations to ensure that:
- Gross IRR that is presented without the impact of any subscription facilities is presented alongside net IRR also without the impact of any subscription facilities; and
- Net IRR presented with the impact of any subscription facilities is presented with one of the following:
- Net IRR without the impact of any subscription facilities, or
- Appropriate disclosure describing the impact of such subscription facilities on net IRR.
Disclosure of Gross IRR and Net IRR With and Without Subscription Facilities
Prior to the adoption of the Marketing Rule, it was not uncommon for private fund sponsors to present gross IRR without the impact of any subscription facilities or other borrowing at the fund level and present net IRR with the impact of any such subscription facilities or other borrowing. The Marketing Rule included a requirement that any gross performance must be presented with equal prominence alongside net performance where the gross and net performance are calculated over the same time period and using the same type of return and methodology. The FAQ confirms that the requirement to use the same methodology means that gross IRR that does not reflect the impact of any subscription facilities must be presented with net IRR that does not reflect the impact of any subscription facilities. (Note that there is no requirement to include gross performance if presenting only net performance, so presenting net IRR with the impact of subscription facilities does not trigger a requirement to present gross IRR with the same methodology.)
Disclosure of Net IRR With Subscription Facilities
This FAQ also represents the first example of the backflow of the performance presentation requirements in the new Quarterly Statements Rule1 (which was adopted as part of the so-called Private Funds Rules2) into the Marketing Rule. Under the Quarterly Statements Rule, an “illiquid fund” is required to present both gross IRR and net IRR with and without the impact of any fund-level subscription facilities in the quarterly statements provided to existing investors.
In the adopting release for the Private Funds Rules, the SEC expressed the belief that performance figures that reflect the impact of fund-level subscription facilities, “alone, have the potential to mislead investors.”3 Particularly, the SEC was concerned that an investor could reasonably believe that the “levered performance results are similar to those that the investor has achieved from its investment in the fund.” While stated as a justification for the requirement for reporting with and without fund-level subscription facilities in the quarterly statements, the position that it could be misleading suggests that it could violate other rules under the Advisers Act as well, including the Marketing Rule (which includes general prohibitions against, among other things, misleading statements in “advertisements,” such as communications soliciting private fund investors) and the Advisers Act Rule 206(4)-8 (which prohibits misleading statements in any communications with private fund investors).
In the new Marketing Rule FAQ, the SEC staff echoes this concern, stating that presenting only net IRR with the impact of fund-level subscription facilities would violate the general prohibitions of the Marketing Rule unless the private fund adviser also presents either “(i) comparable performance (e.g., net IRR without the impact of fund-level subscription facilities) or (ii) appropriate disclosures describing the impact of such subscription facilities on the net performance shown.” The FAQ does not provide any additional guidance on what “appropriate disclosures” will be necessary. In particular, it does not specify whether it is sufficient to include a statement in the performance disclosure that the net IRR reflects the impact of subscription facilities, and that the performance that an investor achieved from an investment in the fund would be different.
 Advisers Act Rule 211(h)(1)-2.
 Private Fund Advisers; Documentation of Registered Investment Adviser Compliance Reviews, SEC Release No. IA-6383 (Aug. 23, 2023)(“Private Funds Rule Adopting Release”).
 Private Funds Rule Adopting Release at the paragraph accompanying fn. 375.