The Securities and Exchange Commission (SEC) recently adopted a final rule (Rule) to raise the requirements for investors who pay performance-based fees. Registered investment advisers may only charge performance fees to “qualified clients” that meet required net worth or assets under management thresholds. The Rule increases these thresholds, as mandated by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), and excludes the value of the client’s primary residence from the net worth calculation.  

Pursuant to the Rule, clients must have at least a $2 million net worth or $1 million of assets under management with the adviser to meet the new qualified client thresholds. Previously, these amounts were $1.5 million and $750,000, respectively. The client’s net worth must now be calculated by excluding the value of the primary residence as well as the debt secured by the residence, up to the fair market value of the residence. The Rule’s raised thresholds conform to amounts set by an SEC order in July 2011.  

A grandfather provision to the Rule allows registered investment advisers to continue charging performance fees to those who were considered qualified clients under the previous threshold amounts and already paying the fees. In the case of private funds, any such investors can continue to make additional investments in the same fund without meeting the new thresholds. Another grandfather provision allows newly registered advisers to continue charging performance fees to clients (or, in the case of private funds, investors) that became clients or investors prior to the adviser registering, regardless of whether those clients or investors were — or are — qualified clients. Additionally, as required by the Dodd-Frank Act, the Rule provides that, every five years, the SEC will make inflation adjustments to the thresholds that determine whether someone is a qualified client and can be charged performance-based fees.  

The Rule will take effect 90 days after publication in the Federal Register, but investment advisers may rely upon the grandfather provisions before then.  

The final Rule may be accessed at: http://www.sec.gov/rules/final/2012/ia-3372.pdf.  

The previous Investment Management Alert summarizing the SEC’s July 2011 order can be read at: http://www.drinkerbiddle.com/qualified_client/.