Change to Definition of Qualified Client

The Securities and Exchange Commission (“SEC”) recently announced an upcoming change to the definition of “qualified client” as defined in Rule 205-3 under the Investment Advisers Act of 1940 (“Advisers Act”) that will become effective August 15, 2016. This applies to any Registered Investment Adviser (“RIA” or “Investment Adviser”) that earns performance based fees.

To provide some background, Section 205(a)(1) of the Advisers Act generally prohibits an investment adviser from entering into, extending, renewing, or performing any investment advisory contract that provides for performance compensation or performance fees.

However, there are certain exemptions from this prohibition. One such exemption under Rule 205-3 exempts an investment adviser from the prohibition discussed above when the client is a qualified client.  The Rule allows an investment adviser to charge performance fees if the client has at least a certain dollar amount in assets under management (currently $1,000,000) or if the investment adviser reasonably believes that the client has a net worth of more than a certain dollar amount (currently $2,000,000).

On May 18, 2016, the SEC published a notice of intent to issue an order that would adjust for inflation, as appropriate, the dollar amount thresholds of the asset-under-management threshold and the net worth threshold for determining whether a client may be considered a qualified client under the Rule’s definition. The SEC stated that, based on calculations that take into account the effects of inflation by reference to historic and current levels of the PCE Index, the dollar amount of the assets-under-management threshold would remain $1,000,000, and the dollar amount of the net worth threshold would increase from $2,000,000 to $2,100,000. This change to the net worth test from $2,000,000 to $2,100,000 will become effective as of August 15, 2016.

Investment advisers earning performance based fees should update its Form ADV and contracts to reflect the new minimum net worth threshold. Investment Advisers will also need to ensure that any new client brought on after August 15, 2016 meets the new minimum net worth threshold in order to be designated as a “qualified client”.
For more information regarding this recent order from the SEC, click here.

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