RIA Compliance Blog
The SEC recently announced its intent to issue an order that will adjust the dollar amount necessary to be considered a “qualified client” under Section 205(a)(1) of the Investment Advisers Act of 1940 (“Advisers Act”). This increase, adjusted to reflect inflation, raises the minimum net worth or dollar amount of assets under management necessary for an investment adviser to charge a performance fee to the client.
Section 205(a)(1) generally prohibits an investment adviser “from entering into, performing, renewing or extending an investment advisory contract that provides for compensation to the investment adviser on the basis of a share of the capital gains upon, or the capital appreciation of, the funds, or any portion of the funds” unless the client is considered a “qualified client”.[1] This update has a large impact on private funds utilizing the 3(c)(1) exemption to the Investment Company Act and Investment Company Act registered funds.
Since 1985, the SEC has exempted investment advisers from the performance fee prohibition if the client meets either an assets-under-management test or a net worth test. The thresholds were initially set at $500,000 for assets-under-management and $1,000,000 for net worth. The Dodd-Frank Act, passed in 2011, instructed the SEC to revisit these thresholds every five years to adjust for the effects of inflation. Since 2016, the SEC’s inflation adjustments have been tied to the Personal Consumption Expenditures Chain-Type Price Index (“PCE Index”).
The 2026 qualified client inflation adjustment is effective June 29, 2026. To be considered a “qualified client” upon effectiveness, a client or private fund investor must have at least $1,400,000 in assets under management with the investment adviser after entering into the advisory relationship. Alternatively, the client or private fund investor must have a net worth greater than $2,700,000. Prior to the 2026 adjustment, these limits were set at $1,100,000 and $2,200,000, respectively.
While the qualified client dollar limit adjustment is not retroactive and may not impact a majority of investment advisers, advisers to private funds will have to update fund documents and internal policies and procedures to stay compliant with Section 205(a)(1) after the June 29, 2026, effective date. Private fund advisers to 3(c)(1) funds should update offering documents and compliance programs to recognize the increased dollar amounts. Additionally, advisers with open funds should review any planned closings scheduled after the effective date to ensure that all prospective investors still qualify as qualified clients under the new limits.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Investment Adviser Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Investment Adviser Practice Group page for more information.
[1] 15 U.S.C. 80b-5(a)(1).