The U.S. Investment Advisers Act of 1940 ("Advisers Act") prohibits an investment adviser registered with the U.S. Securities and Exchange Commission ("SEC") from entering into, extending, renewing, or performing an investment advisory contract that provides for compensation to the adviser based on a share of capital gains on, or capital appreciation of, the funds of a client (e.g., performance-based compensation such as carried interest or a performance fee). However, Rule 205-3 under the Advisers Act exempts an investment adviser from the foregoing prohibition if the client is a "qualified client."
Rule 205-3 under the Advisers Act currently defines a "qualified client" to include a person that has at least $1,000,000 under the management of the investment adviser or a net worth of more than $2,000,000.
On June 14, 2016, the SEC published an order approving adjustment for inflation of the dollar amount thresholds in Rule 205-3. The amount of the assets under management, or AUM, threshold (i.e., $1,000,000) will remain the same, but the amount of the net worth threshold will increase to $2,100,000. The effective date of the net worth threshold increase is August 15, 2016. To the extent that contractual relationships (that is, advisory agreements or subscription agreements) are entered into prior to August 15, 2016, the current net worth standard will apply.
Investment advisers registered with the SEC—in particular, those investment advisers that advise clients with managed accounts, or funds that rely on Section 3(c)(1)—should ensure that advisory agreements and subscription agreements entered into with new clients or investors on or after August 15, 2016, contain the new net worth standard.