The Securities and Exchange Commission (SEC) has adopted amendments to Rule 205-3 under the Investment Advisers Act of 1940 that become effective on May 22, 2012. These amendments present challenges for investment advisers that collect performance-based fees from “qualified clients.”

Investment advisers and sponsors of private investment funds should take note of the following significant features:

• The qualified client tests, requiring that each client paying a performance-based fee meet a minimum net worth or assets-under-management threshold, will be automatically adjusted every five years for the effects of inflation.
• The method of computing a potential qualified client’s net worth has been revised.
• Advisers to 3(c)(1) funds must look through their fund-of-funds investors when applying the qualified client test, and must apply the thresholds applicable at the time of the fund-of-funds investment, potentially affecting the ability to charge performance fees to investing funds-of-funds with some investors that no longer meet the qualified client tests.

Partner Bertrand Fry, Co-Chair of Pryor Cashman’s Investment Management Group, and associate Jill Braibanti have authored a Legal Update reviewing these changes, recommending best practices for updating subscription agreements, and attaching a comparison chart of investor tests commonly applicable to private investment funds.

To read the update, entitled "Changes in the “Qualified Client” Test: Challenges for Investment Advisers Charging Performance Fees," please click here.