On July 12, 2011, the SEC issued an order increasing the dollar-amount thresholds used to determine whether an advisory client, or an investor in a private fund, is a “qualified client” that may be charged a performance fee by its investment adviser under Rule 205-3 under the Advisers Act. The order can be found here.
Under the revised thresholds, a client/investor will satisfy the dollar-amount threshold to be a “qualified client” if the client/investor has at least $1 million under management with the adviser immediately after entering into the advisory contract or the adviser reasonably believes that the client/investor has a net worth of more than $2 million immediately prior to entering into the advisory contract. These increases from the current thresholds of $750,000 and $1.5 million, respectively, were adopted as a result of the Dodd-Frank Act’s requirement that the SEC adjust these dollar-amount thresholds for inflation every five years beginning no later than July 21, 2011. Other provisions of Rule 205-3 that provide other means of satisfying the qualified client definition — i.e., “qualified purchasers” under the 1940 Act and persons with specified relationships with an adviser — are unaffected by the order.
Advisers should update their client and investor questionnaires in light of these threshold changes, which become effective September 19, 2011.
As we previously reported here, on May 10, 2011 the SEC proposed other changes to Rule 205-3 that, very generally, would exclude the value of a person’s primary residence (and related mortgage debt) from the calculation of a client’s net worth and provide a transition rule for existing performance fee arrangements that do not satisfy the new thresholds but (i) were permissible at the time the advisory contracts were entered into or (ii) were entered into by an investment adviser at a time when it was exempt from registration with the SEC. In its July 12, 2011 press release announcing the dollar threshold changes (which can be found here), the SEC staff indicated that these proposed amendments to Rule 205-3 are “currently under consideration.”