Effective as of August 15, 2016, the Securities and Exchange Commission ("SEC") has amended the definition of a "qualified client" to increase the dollar amount threshold under the net worth test for qualified client status from $2 million to $2.1 million. The dollar amount threshold under the assets under management test for qualified client status remains unchanged at $1 million.
Background
Section 205(a)(1) of the Investment Advisers Act of 1940 (the "Advisers Act") generally prohibits investment advisory contracts which provide for performance compensation or performance fees, including incentive fees or carried interest. Rule 205-3 under the Advisers Act provides an exemption from such prohibition when the client is a "qualified client."
Section 205(e) of the Advisers Act now provides that a client (including an investor in a fund relying upon the exemption from registration provided under Section 3(c)(1) of the Investment Company Act (a "3(c)(1) fund")) constitutes a "qualified client" if either:
(i) immediately after entering into a contract with a federally registered investment adviser, such client has at least $1 million under management of the investment adviser; or
(ii) immediately prior to entering into a contract with a federally registered investment adviser, the investment adviser entering into the contract (and any person acting on its behalf) reasonably believes such client has a net worth (together with assets held jointly with a spouse) of more than $2.1 million.
The Dodd-Frank Wall Street Reform and Consumer Protection Act amended Section 205(e) of the Advisers Act to provide that the assets under management and net worth tests for qualified client status would be updated every five years by the SEC to adjust for inflation (rounding to the nearest $100,000). The SEC last adjusted the dollar amount thresholds effective as of September 19, 2011, setting the assets under management test threshold at $1 million and the net worth test threshold at $2 million. The SEC determined that the assets under management test threshold would be revised upward to $2.1 million for the next five years. Due to rounding (and low inflation), the net worth test threshold remains unchanged at $1 million for the next five years.
Next Steps
The assets under management test threshold has been adjusted as of August 15, 2016, but the change should not impact contracts (including subscription agreements of 3(c)(1) funds) entered into prior to such date. Going forward, federally registered investment advisers may need to update their investment advisory agreements and subscription and offering documents for ongoing offerings of 3(c)(1) funds to account for the change in the threshold.
The text of the SEC's order approving the adjustment described herein may be found here.
Please contact any of the attorneys listed, or any other member of Lowenstein Sandler's Investment Management Group, for further information on the matters discussed herein.
