SEC Announces Intent To Increase ‘Qualified Client’ Thresholds Under Rule 205-3
Key Takeaways
- On March 27, 2026, the Securities and Exchange Commission (SEC) published a notice of intent to issue an order adjusting for inflation the dollar amount thresholds included in the “qualified client” definition in Rule 205-3 under the U.S. Investment Advisers Act of 1940, as amended (the Advisers Act).
- The proposed order would increase the assets under management test threshold from $1,100,000 to $1,400,000 and the Net Worth Test threshold from $2,200,000 to $2,700,000.
- If issued, the order will become effective 60 days following issuance. The current anticipated date for issuance is on or about May 1, 2026. The adjusted thresholds will generally not apply retroactively.
- Investment advisers should begin reviewing and updating their subscription documents and any additional documents that provide the qualified client threshold amounts.
Background
Section 205(a)(1) of the Advisers Act generally prohibits an investment adviser from entering an investment advisory contract that provides performance-based compensation. However, Rule 205-3 promulgated under the Advisers Act provides an exemption from this prohibition, permitting investment advisers to charge performance-based fees to clients who qualify as “qualified clients” (the Qualified Client Exemption).
Under Rule 205-3, a client is a “qualified client” if either: (1) immediately after entering into a contract with an investment adviser, the client has at least a specified minimum dollar amount of assets under management with the adviser (the AUM Test); or (2) immediately prior to entering into a contract with an investment adviser, the adviser reasonably believes that the client has a net worth in excess of a specified minimum dollar amount (the Net Worth Test). As of August 16, 2021, the specified dollar amounts under the AUM Test and the Net Worth Test were set as $1,100,000 and $2,200,000, respectively.
The Proposed Adjustments
Pursuant to Section 418 of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act and Rule 205-3(e), the SEC is required to adjust the qualified client thresholds for inflation every five years. The SEC intends to issue an order that would increase both qualified client thresholds as follows:
| Test | Threshold as of August 16, 2021 | Newly Proposed Threshold |
|---|---|---|
| AUM Test | $1,100,000 | $1,400,000 |
| Net Worth Test | $2,200,000 | $2,700,000 |
The net worth determination continues to exclude the value of the client’s or investor’s primary residence and certain related debt.
Effective Date and Transition Rules
If issued, the order’s effective date will be 60 days following the issuance. The order is currently anticipated to be issued on or about May 1, 2026.
Importantly, the adjusted thresholds will generally not apply retroactively to existing client relationships or investors in private funds. Pursuant to Rule 205-3(c)(1), an investment adviser that has entered into a contract with a client providing for performance-based compensation that satisfied the Qualified Client Exemption at the time the contract was entered into will be considered to continue to satisfy the conditions of the rule. However, if a client becomes a party to the contract after the order’s effective date, the new thresholds will apply with respect to such client.
Next Steps for Investment Advisers
In light of the proposed threshold increases, investment advisers should consider amending their form subscription documents to the extent that any questionnaires or investor representations reference qualified client threshold amounts. Advisers should also consider amending any additional client agreements that provide for performance fees and reference specific qualified client threshold amounts.
For any questions about this Update, please contact your firm relationship lawyer or any of the authors.
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