SEC Increases “Qualified Client” Standards
On June 17, 2021, the U.S. Securities and Exchange Commission (the “SEC”) issued an order (the “Order”1) increasing the dollar amount tests in order to qualify as a “qualified client” in Rule 205-3 (the “Rule”) under the Investment Advisers Act of 1940, as amended (the “Advisers Act”). As described below, these changes will be effective on August 16, 2021 (the “Effective Date”).
Generally, SEC-registered investment advisers are prohibited from charging performance-based compensation to clients residing in the United States, unless they are “qualified clients” under the Rule. A “qualified client” has
- a certain minimum dollar amount in assets under management (currently, $1,000,000) with the adviser immediately after entering into an advisory contract (the “AUM Test”) or
- has a net worth of more than a certain dollar amount (currently, $2,100,000) immediately prior to entering into an advisory contract with the adviser (the “Net Worth Test”).
The prohibition regarding performance-based compensation and the exemption provided by the Rule also applies to investors in private funds organized in the United States.2
On the Effective Date, the AUM Test will increase to $1.1 million and the Net Worth Test will increase to $2.2 million. Advisers should update their managed account agreement forms and fund offering documents as appropriate. Performance-based compensation arrangements with clients and fund investors that were in place prior to the Effective Date generally will not be affected by the Order.
1 The Order can be found here.
2 Pursuant to Section 205(b)(5) of the Advisers Act, a registered adviser can charge performance-based compensation to an offshore fund regardless of whether the fund has U.S. investors.