With effect on June 29, 2026, the Securities and Exchange Commission (the “SEC”) has implemented its periodic adjustment to the dollar amount thresholds used to determine “qualified client” status under Rule 205-3 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”). The assets-under-management test increases from $1,100,000 to $1,400,000, and the net worth test increases from $2,200,000 to $2,700,000.¹

Background

Section 205(a)(1) of the Advisers Act generally prohibits SEC-registered investment advisers (“RIAs”) from receiving compensation based on a share of capital gains on, or capital appreciation of, the funds of a client (i.e., performance fees). Rule 205-3 under the Advisers Act creates an exemption from the prohibition on charging performance fees when the client satisfies either the assets-under-management test or the net worth test (i.e., the client is a “qualified client”). Additionally, certain knowledgeable employees of an RIA (as set forth in Rule 205-3) and “qualified purchasers” (as defined under Section 2(a)(51) of the Investment Company Act of 1940, as amended (the “Investment Company Act”)) are automatically deemed to be qualified clients. Under Section 205(b)(5) of the Advisers Act, RIAs are not prohibited from charging performance fees to clients that are not residents of the United States. However, for RIAs that advise private funds, including non-U.S. private funds, excepted from the definition of “investment company” under Section 3(c)(1) of the Investment Company Act (“3(c)(1) Funds”), the prohibition applies a “look-through” that treats each investor as a “client,” and thus each U.S. investor in the 3(c)(1) Funds that an RIA advises must be a qualified client in order to be charged performance fees.

As part of the reforms introduced in the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC was directed to update the dollar amount thresholds for qualified client eligibility every five years to account for the effects of inflation. The SEC is next scheduled to adjust these thresholds in 2031.

Increased Thresholds

To satisfy the assets-under-management test after the June 29 effective date, a client must have, immediately after entering into the applicable advisory contract, at least $1,400,000 under the management of the RIA.² To satisfy the net worth test after the June 29 effective date, the RIA must reasonably believe, immediately prior entering into the applicable advisory contract, a client has a net worth (in the case of a natural person, together with assets held jointly with a spouse) of more than $2,700,000, excluding the value of the client’s primary residence and related debt.³

The increased dollar amount thresholds do not apply to an RIA’s existing clients, provided that the relevant advisory contract was entered into prior to the June 29 effective date or at a time when the RIA was not registered, or required to be registered, with the SEC as an investment adviser.

The relevant date for determining which thresholds apply for clients putting additional funds into their accounts is the date of the advisory contract, not the date a client’s funds are made available to the investment adviser. However, contract renewals or extensions are not grandfathered in, but are treated as new contracts as of the date of the renewal or extension, and clients must meet the qualified client thresholds in effect on that date.

If additional clients become parties to a pre-existing advisory contract, these additional clients will have to meet the qualified client thresholds as of the date they join the contract, but the addition of new clients will not affect the status of any existing clients.

Practice Notes

Private Funds Relying on Section 3(c)(7). Under Section 205(b)(4) of the Advisers Act, the prohibition on RIA’s charging performance-based fees does not apply to private funds that are excepted from the definition of “investment company” under Section 3(c)(7) of the Investment Company Act, and thus have only “qualified purchasers” (including knowledgeable employees of the RIA) as investors.

Subscription Agreement Updates. RIAs should review the subscription agreements and other offering documents of any 3(c)(1) Funds they advise to determine if the qualified client thresholds need to be updated. Going forward, RIAs should also ensure that the threshold increases are reflected in any investment management agreements that provide for performance fees and reference the qualified client thresholds.

Special Considerations for Investors that are Funds of Funds. The prohibition on performance fees also applies on a look-through basis to 3(c)(1) Funds that invest in other 3(c)(1) Funds. When a 3(c)(1) Fund (the “Investing Fund”), such as a fund-of-funds, invests in another 3(c)(1) Fund (the “Investee Fund”), the investment adviser to the Investee Fund, for purposes of Rule 205-3, must count as its clients all investors in the Investing Fund. To the extent that any of the Investing Fund’s investors are not qualified clients at the time the Investing Fund makes its investment in the Investee Fund, the Investee Fund would be required to adjust its performance fee with respect to the Investing Fund to ensure that any indirect investors that are not qualified clients are excluded from the performance fee calculation. RIAs that rely on the qualified client exception to collect performance fees from other 3(c)(1) Funds should ensure such 3(c)(1) Funds and their documents are structured to address this scenario.