Securities Regulation Daily Wrap Up, INVESTMENT ADVISERS—SEC amends rule on inflation adjustments of qualified client thresholds for performance-based fees, (Nov 8, 2021)

By Elena Eyber, J.D.

The SEC amended Advisers Act Rule 205-3, a rule that permits investment advisers to charge performance-based compensation to “qualified clients.”

According to the SEC’s fact sheet, the SEC amended Rule 205-3 to streamline the process relating to the adjustment of the assets-under-management and net worth tests for “qualified client” status and to ensure that the rule text remains consistent with the inflation adjustment orders issued by the SEC. Rule 205-3 defines “qualified client” with reference to specific dollar amount thresholds, which are required to be adjusted every five years to account for the effects of inflation. These amendments replace specific dollar amount thresholds in the rule’s “qualified client” definition with references to the SEC’s “most recent order,” as defined by the amended rule, containing the specific dollar amount thresholds adjusted for inflation (Performance-Based Investment Advisory Fees, Release No. IA-5904, November 4, 2021).

The Advisers Act generally prohibits investment advisers registered with the SEC from entering into or performing any investment advisory contract that provides for compensation to the adviser in the form of performance fees. Rule 205-3 exempts an investment adviser from the prohibition when the client is a “qualified client,” which includes a client that meets an assets-under-management test or a net worth test.

The Advisers Act requires that the SEC, by order, adjust for the dollar amount thresholds of those two qualified client tests. The SEC most recently issued an order on June 17, 2021, effective as of August 16, 2021, increasing for the effects of inflation the dollar amount threshold of the assets-under-management test from $1,000,000 to $1,100,000 and the dollar amount threshold of the net worth test from $2,100,000 to $2,200,000.

Upon effectiveness, the text of Rule 205-3 will refer to the most recent order issued by the SEC on June 17, 2021. The SEC will next adjust the thresholds for the effects of inflation on May 1, 2026.

The release is No. IA-5904.

RegulatoryActivity: DoddFrankAct InvestmentAdvisers InvestmentCompanies