On July 12, 2011, the Securities and Exchange Commission (SEC) issued an order1 raising the asset thresholds for individuals to meet the “qualified client” standard under Rule 205-3 of the Investment Advisers Act of 1940 (Advisers Act). The Advisers Act generally prohibits registered investment advisers from charging performance fees to clients other than qualified clients. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) requires the SEC to update the qualified client standard to adjust for inflation no later than July 21, 2011, and requires additional adjustments for inflation every five years thereafter.
The order modifies Rule 205-3 to define a qualified client as: 1) a person with at least $1 million under the management of the adviser or 2) a person whose net worth (including joint assets with a spouse) exceeds $2 million. The previous thresholds of $750,000 of assets under management with the adviser and $1.5 million in net worth were last revised in 1998. The order will be effective as of September 19, 2011.
The SEC had previously issued a notice of intent to issue the order along with a rulemaking proposal.2 The rulemaking proposal requested public comment on additional changes to Rule 205-3. These proposed rule changes would 1) determine how the SEC adjusts the qualified client standard for inflation, 2) exclude the value of a primary residence from the qualified client net worth test (the same change that was recently made with respect to the accredited investor standard) and 3) grandfather in existing advisory contracts of A) clients who met the previous qualified client requirements and B) investment advisers who were previously exempt from registration with the SEC.
These additional changes to Rule 205-3 are not required by the Dodd-Frank Act and are still under consideration by the SEC. The deadline for comments was July 11, 2011.