Tonkon

Legal Updates & Alerts

SEC Raises "Qualified Client" Thresholds

August 3, 2011
By Craig Foster

On July 12, 2011, the Securities and Exchange Commission ("SEC") issued an order (the "Order") raising the financial thresholds under Rule 205-3 under the Investment Advisers Act of 1940 (the "Advisers Act"), which permits registered investment advisers to charge certain clients a performance-based fee. The changes will be effective September 19, 2011.

Background. The Advisers Act generally provides that SEC-registered advisers may only charge performance-based fees to "qualified clients." Currently, under Rule 205-3, qualified clients include natural persons with:
  • At least $750,000 in assets under management with the adviser immediately after entering into the advisory contract (the "assets under management test"); or
  • A net worth (together with assets held jointly with a spouse) of more than $1.5 million at the time of entering into the advisory contract (the "net worth test").

Increased Thresholds. As we discussed in a previous Tonkon Tip, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank") requires the SEC to adjust those thresholds for inflation. The Order does this by raising the threshold for the assets under management test to $1 million and the threshold for the net worth test to $2 million.

Proposed Amendments to Rule 205-3. While the Order raises the thresholds for qualified clients, the SEC has not yet finalized proposed amendments to Rule 205-3 that:
  • Provide that the SEC will issue an order every five years adjusting the thresholds for inflation;
  • Exclude the value of a natural person's primary residence from the determination of whether the person meets the net worth test;
  • Implement certain transition rules to allow advisers to maintain existing performance-based fee arrangements that complied with Rule 205-3 at the time they were entered into.

The comment period on those proposed amendments is now closed, and we will update you once the SEC issues the final rule. For further questions concerning investment adviser regulation under Dodd-Frank, please contact our Financial Services practice group.