SEC raises “qualified client” thresholds for Advisers Act Rule 205-3 performance fee prohibition exemption

On April 28, 2026, the Securities and Exchange Commission (the "Commission") issued Release No. IA-6961 (the "Order"), approving an inflation adjustment to the dollar amount thresholds used to determine "qualified client" status under Rule 205-3 of the Investment Advisers Act of 1940 (the "Advisers Act").

Legal Landscape

Section 205(a)(1) of the Advisers Act generally prohibits investment advisers that are registered with the SEC as investment advisers ("Registered Investment Advisers") from entering into or performing any investment advisory contract that provides for compensation based on a share of the capital gains or appreciation in the value of a client's funds. This type of compensation is commonly referred to as "performance compensation" or "performance fees." Analogous restrictions on performance compensation may apply to investment advisers that are subject to state investment advisory laws.

Rule 205-3 under the Advisers Act exempts a Registered Investment Adviser from this prohibition when the client being charged the performance fee qualifies as a "qualified client." A client satisfies this standard either (i) through an assets-under-management test, by having at least a specified dollar amount in assets under management with the adviser immediately after entering into the advisory contract, or (ii) through a net worth test, if the adviser reasonably believes, immediately prior to entering into the contract, that the client has a net worth exceeding a specified dollar amount. This qualified client requirement applies on both a direct and indirect basis. Clients that satisfy the definition of "qualified purchaser" set forth in Section 2(a)(51) of the US Investment Company Act of 1940, as amended (the "Investment Company Act") are automatically qualified clients for the purposes of Rule 205-3.

The Dodd-Frank Wall Street Reform and Consumer Protection Act amended Section 205(e) of the Advisers Act to require the Commission to adjust these dollar amount thresholds for the effects of inflation by order every five years, rounded to the nearest multiple of $100,000.

New Thresholds

Based on calculations considering the effects of inflation by reference to historic and current levels of the Personal Consumption Expenditures Chain-Type Price Index, published by the United States Department of Commerce, the thresholds are adjusted as follows:

Summary of Order

• New Assets-Under-Management Threshold. For purposes of the assets-under-management test, a "qualified client" means a natural person or legal entity (including limited partnerships and irrevocable trusts) that, immediately after entering into the contract, has at least $1,400,000 under the management of the Registered Investment Adviser.
• New Net Worth Threshold. For purposes of the net worth test, a "qualified client" means a natural person or legal entity that the Registered Investment Adviser reasonably believes, immediately prior to entering into the contract, has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than $2,700,000.
• Effective Date. The effective date of the Order is June 29, 2026.
• No Retroactive Application for Existing Contracts. The adjusted thresholds will generally not apply retroactively to contractual relationships that were entered into prior to the Order's effective date, subject to the transition rules set forth in Rule 205-3.¹

Key Takeaways

Institutional funds that raise money in the United States typically restrict investment to subscribers that are qualified purchasers and rely upon the exception from "investment company" afforded by Section 3(c)(7) of the Investment Company Act and will therefore continue to satisfy the requirements of Rule 205-3. Nonetheless, there are still large numbers of US and non-US private funds with US investors that rely upon Section 3(c)(1). The subscription agreements for any such funds that charge performance fees should be updated prior to June 29, 2026, to ensure that investors admitted to such funds are qualified clients.

Importantly, the performance fee limitation imposed by Rule 205-3 also applies on an indirect basis. SEC-registered investment advisers are not permitted to charge private funds that rely upon the exception from the definition of "investment company" afforded by Section 3(c)(1) of the Investment Company Act performance fees to the extent such 3(c)(1) funds have investors that are not qualified clients. If a fund accepts subscriptions from funds of funds, including secondary funds, and those funds are not held entirely by qualified purchasers, the underlying investee fund must discount its performance-based fees by the amount necessary to exclude from its performance fee calculations the indirect investors that are not qualified clients. Many subscription agreements in the market do not include screens to identify the indirect participation of persons that are not qualified clients that may be investors in 3(c)(1) funds that independently qualify as qualified purchasers.

The subscription agreements for funds that (a) are managed by Registered Investment Advisers, (b) are subject to performance fees payable by investors that are not qualified purchasers, and (c) will be accepting subscriptions on or after the effective date of the Order (or that invest after the effective date) in funds that (x) charge performance fees, and (y) are managed by Registered Investment Advisers, should be updated to reflect the new thresholds.

Existing 3(c)(1) funds that invest after the effective date in funds managed by registered investment advisers similarly should ascertain which of their investors are not qualified clients.

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_{This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.}

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