SEC Raises Qualified Client Thresholds

The changes that were recently announced by the US Securities and Exchange Commission to the threshold dollar amounts for the net worth and assets under management requirements to qualify as a “qualified client” under the US Investment Advisers Act of 1940, as amended (Advisers Act) will come into effect on August 16, 2021. These changes were promulgated by the SEC in June of 2021 pursuant to the authority granted to the SEC in Section 205 of the Advisers Act.

From and after August 16, 2021, the “assets under management test” threshold will increase from $1 million to $1.1 million and the “net worth test” threshold will increase from $2.1 million to $2.2 million. These thresholds are set forth in section (d)(1) of Advisers Act Rule 205‑3.

The Advisers Act provides that SEC registered investment advisers generally are prohibited from charging performance-based fees (which include incentive allocations and carried interest distributions) from their clients unless an exception applies. One such exception applies with respect to “qualified clients” that meet one of the tests set forth in Advisers Act Rule 205-3. Following the effectiveness of the increases described above, the “assets under management test” in Rule 205-3 will permit registered investment advisers to charge performance-based fees from any client that has at least $1.1 million in assets under management with the adviser. Similarly, the “net worth test” in Rule 205-3 will permit investment advisers to charge performance-based fees from any client that has a net worth, as determined in accordance with the methodology set forth in section (d)(1)(A) of Rule 205-3, in excess of $2.2 million. These thresholds were last revised by the SEC in 2016. Regulators in many states have applied a similar requirement with respect to performance-based fees charged by state registered investment advisers and investment advisers that qualify as “exempt reporting advisers” for purposes of the laws in such states.

The qualified client threshold increases are not retroactive—qualified clients that met the assets under management test or the net worth test under the prior thresholds generally will be grandfathered for purposes of performance-based fee obligations established in contracts executed prior to the August 16, 2021 increase. The definition of “qualified purchaser” as set forth in Section 2(a)(51) of the US Investment Company Act of 1940, as amended, has not changed, nor has the qualified client status of qualified purchasers.

Investment advisers that are registered with the SEC or are registered with or reporting to relevant state investment management regulators are reminded to review their investment management contracts, private fund offering materials and other documentation, including private placement memoranda, subscription documents, limited partnership agreements, and internal policies and procedures to determine whether any updates are required to reflect these increases in the qualified client thresholds.

© Arnold & Porter Kaye Scholer LLP 2021 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.