SEC Increases Slightly ‘Qualified Client’ Dollar Amount Thresholds

On June 17, 2021, the Securities and Exchange Commission (SEC) issued an order (the “Order”) approving a revision to Rule 205-3 under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), which exempts investment advisers from the general prohibition against charging clients performance fees when the client is a “qualified client,” increasing the dollar amount thresholds that must be met in order for a client to be considered a qualified client.

Generally, under Section 205(a)(1) of the Advisers Act, an investment adviser may not enter into any investment advisory contract that provides for compensation to the investment adviser based on a share of capital gains on, or capital appreciation of, the funds of a client (which are commonly referred to as performance fees).

However, pursuant to Rule 205-3 under the Advisers Act, an adviser may charge performance fees to a client (i) if such client has at least a certain dollar amount in assets under management with the adviser immediately after entering into the advisory contract (the “assets-under-management test”) or (ii) if the adviser reasonably believes, immediately prior to entering into the contract, that the client has a net worth of more than a certain dollar amount (the “net worth test”).

Under the current Rule 205-3, in order to qualify as a qualified client, a client must have at least $1 million in assets under management with the adviser to qualify under the assets-under-management test or a net worth of $2.1 million to qualify under the net worth test. The revisions to Rule 205-3 adjust each of these thresholds upward due to inflation, to $1.1 million and $2.2 million, respectively.

The Order becomes effective Aug. 16, 2021. Relationships entered into prior to such date will not be impacted.

Learn more about the revision to Rule 205-3 under the Investment Advisers Act of 1940.