Effective as of August 15, 2016, the dollar amount of the “qualified client” net worth test will increase from $2,000,000 to $2,100,000.

On June 14, 2016, the SEC issued an Order Approving Adjustment for Inflation of the Dollar Amount Tests in Rule 205-3 under the Investment Advisers Act of 1940 (the “Advisers Act”).1  Rule 205-3 provides an exemption from the Advisers Act’s prohibition on performance-based compensation where the client entering into the advisory contract is a “qualified client” as defined in the rule.  Currently, the definition of a “qualified client” includes a natural person who, or a company that:

  • immediately after entering into the contract has at least $1,000,000 under the management of the investment adviser; or
  • the investment adviser entering into the contract (and any person acting on his behalf) reasonably believes, immediately prior to entering into the contract, either: (i) has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than $2,000,000 or (ii) is a qualified purchaser as defined in section 2(a)(51)(A) of the Investment Company Act of 1940 at the time the contract is entered into.​2

Effective as of August 15, 2016, the dollar amount of the net worth test will increase from $2,000,000 to $2,100,000.  The Order was issued pursuant to section 205(e) of the Advisers Act and section 418 of the Dodd-Frank Act, which requires the SEC to issue an order every five years to adjust for inflation the dollar amount thresholds in Rule 205-3’s assets-under-management and net worth tests based on the Personal Consumption Expenditures Chain-Type Price Index (“PCE Index,” published by the United States Department of Commerce), rounded to the nearest $100,000.  The dollar amount of the assets-under-management test will remain $1,000,000 because the amount of the SEC’s inflation adjustment calculation is smaller than the rounding amount required by the rule.

Generally, the increase in the net worth test is not retroactive.  Current contracts that satisfy the conditions of Rule 205-3 at the time the contracts were entered into, including those relying on the dollar amount of the net worth test then in effect, will be considered to satisfy the conditions of Rule 205-3.  However, if a natural person or company who was not a party to the contract becomes a party (including an equity owner of a private investment company advised by the adviser), the conditions of Rule 205-3 and the dollar amount of the net worth test in effect at that time will apply with regard to that person or company (subject to the transition rules for investment advisers who were not previously registered prior to the Dodd-Frank Act’s implementation). 

Investment advisers who charge performance fees—both those who are registered with the SEC and those who are registered under state laws that require compliance with Advisers Act Section 205 and SEC Rule 205-3—should consult with counsel and update as applicable their current investment advisory agreements and investment fund offering documents to conform to the new threshold.

For more information regarding recent SEC regulatory action on investment adviser performance fees, please see our June 13, 2016, Client Alert - The SEC Proposes Rules to Address Investment Advisor and Broker-Dealer Incentive Based Compensation.


1.   On May 18, 2016, the SEC published a notice of intent to issue the Order and established a deadline of June 13, 2016 for submission of requests for a hearing.  No requests for a hearing were received.
2.   The definition also includes a natural person who immediately prior to entering into the contract is: (i) an executive officer, director, trustee, general partner, or person serving in a similar capacity, of the investment adviser; or (ii) an employee of the investment adviser (other than an employee performing solely clerical, secretarial or administrative functions with regard to the investment adviser) who, in connection with his or her regular functions or duties, participates in the investment activities of such investment adviser, provided that such employee has been performing such functions and duties for or on behalf of the investment adviser, or substantially similar functions or duties for or on behalf of another company for at least 12 months.