November 28, 2021

Volume XI, Number 332

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SEC Adopts Higher Net Worth Threshold for Qualified Clients under the Advisers Act

In an order dated June 14, 2016, the Securities and Exchange Commission (SEC) adopted its prior proposal to increase the net worth threshold for “qualified clients” under Rule 205-3 of the Investment Advisers Act of 1940 (the Advisers Act) from $2 million to $2.1 million. This adjustment is being made pursuant to a five-year indexing adjustment required by §205(e) of the Advisers Act.

Registered investment advisers generally are prohibited by §205(a)(1) of the Advisers Act from charging performance-based compensation. An exemption from this prohibition is provided by Rule 205-3 under the Advisers Act for clients that meet the definition of a “qualified client.”

Currently, Rule 205-3 provides that in order to be a qualified client, a client must have either (i) at least $1 million of assets under the management of the investment adviser[1], or (ii) a net worth (together, in the case of a client which is a natural person, with assets held jointly with a spouse) which the investment adviser reasonably believes to be in excess of $2 million.[2]  These amounts were last adjusted on September 19, 2011, when the assets under management threshold was increased from $750,000, and the net worth threshold was increased from $1.5 million.  A qualified client also includes both a “qualified purchaser” as defined in §2(a)(51)(A) of the Investment Company Act of 1940 (the Investment Company Act) and an investment adviser’s knowledgeable employees.

A sponsor of a §3(c)(1) fund must be mindful of Rule 205-3(b) under the Advisers Act, which provides that each equity owner of a §3(c)(1) fund will be considered a client of the fund’s advisor for purposes of determining qualified client status. In contrast, this “look through” provision is not applicable to private funds relying on §3(c)(7) of the Investment Company Act.

The effective date of the increase of the net worth threshold is Monday, August 15, 2016.

The new net worth threshold will not be retroactively applied to advisory contracts entered into prior to the effective date. However, sponsors of §3(c)(1) funds should be aware of a couple of important implications.  First, prospective investor net worth representations in subscription agreements for any §3(c)(1) funds with closings on or after the effective date should reflect the updated threshold.  Second, documents used in effectuating secondary transfers of ownership interests in existing §3(c)(1) funds should also contain representations to reflect the revised net worth requirements.


[1] Because the indexing adjustment required to be made to the current $1 million assets under management threshold is smaller than the rounding amount specified under Rule 205-3(e) of the Advisers Act, the SEC is not adopting a change to the $1 million assets under management threshold at this time.

[2] While a natural person’s primary residence must not be included as an asset, indebtedness secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time the investment advisory contract is entered into, may be excluded as a liability (subject to limitations in the case of recently acquired debt).  Additionally, indebtedness that is secured by the person’s primary residence in excess of the estimated fair market value of the residence must also be included as a liability.

© 2021 Proskauer Rose LLP. National Law Review, Volume VI, Number 175
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About this Author

Anthony M. Drenzek, Special regulatory Counsel, Proskauer Rose, Attorney, Finance Policy Lawyer
Special Regulatory Counsel

Tony is special regulatory counsel in the Corporate Department and a member of the Private Funds Group and the Private Equity & Hedge Fund Litigation team. His practice focuses on advising U.S. and offshore private fund managers on all aspects of federal, state and SRO organizational and operational compliance, with a specific emphasis on the Investment Advisers Act of 1940.

Tony assists U.S. and offshore private fund clients in registering with the SEC as investment advisers, or reporting as exempt reporting advisers, and complying with...

617.526.9655
Michael F Mavrides, Proskauer Rose Law Firm, Private Investment Attorney
Partner

Michael F. Mavrides is a Partner in the Hedge Funds Group. Mike focuses his practice on representing domestic and offshore hedge funds, funds of funds and other private investment funds, including private equity and real estate investment funds. He regularly advises funds and their managers on a wide variety of issues, including formation and structuring, seed capital, anchor capital and other strategic arrangements, placement agency, solicitation and other marketing arrangements, succession planning, separately managed accounts, and all types of portfolio management, trading and...

212-969-3670
Robert G Leonard, Proskauer Rose Law Firm, Private Investment Attorney
Partner

Robert G. Leonard is a Partner in the Hedge Funds Group. For more than 25 years Rob has been structuring, organizing and representing hedge funds, funds of funds and other private investment funds (both domestic and offshore) and investment advisers.

212-969-3355
Christopher M Wells, Proskauer Rose Law Firm, Private Investment Attorney
Partner

Christopher M. Wells is a Partner and head of the Hedge Funds Group. Chris advises hedge funds, funds of funds and other pooled investment vehicles and their managers on all aspects of fund formation, operations and compliance.

212-969-3600
Howard Beber, Tax Attorney, Proskauer Rose Law Firm
Partner

Howard J. Beber is a partner in the Corporate Department and co-head of the Private Funds Group, which is recognized by Chambers GlobalChambers USA and US Legal 500. His practice focuses on representing private equity funds and institutional investors on a broad range of issues including fund formations, secondary transactions and portfolio investments. 

Howard is actively involved in all stages of fund formation and fund sponsor representation, counseling on terms and marketing strategy, preparing offering documents...

617-526-9754
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