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Volume XII, Number 24


January 21, 2022

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SEC Increases Registered Investment Adviser Performance Compensation Net-Worth and Assets-Under-Management Tests

Key Points

  • Effective as of August 16, the dollar amount tests specified in the definition of “Qualified Client” in Rule 205-3 under the Investment Advisers Act of 1940 (Advisers Act) will increase for the net-worth threshold from $2.1 million to $2.2 million and for the required assets-under-management threshold from $1 million to $1.1 million. As a result, federally registered investment advisers (RIAs) should consider taking the following actions to with respect to their documentation:

    • RIAs who charge performance fees should revise applicable net-worth and assets-under-management representations in their 3(c)(1) fund subscription agreements to reflect the updated thresholds for new separately managed account clients and 3(c)(1) fund investors.

    • RIAs who manage separately managed accounts should update their investment advisory agreements for future clients to reflect the increased applicable net-worth and assets-under-management thresholds and/or update their due diligence documentation to remain consistent with the updated definition of “Qualified Client.”

Changes to the “Qualified Client” Definition

Section 205 under the Advisers Act generally prohibits an RIA from receiving compensation based on a share of the capital gains on or appreciation of the assets of an advisory client (i.e., performance fees). Rule 205-3 under the Advisers Act provides an exemption from this prohibition for clients that meet the definition of “Qualified Client” found in the rule.

Currently, the definition of Qualified Client includes, among other persons, a company that, or a natural person who:

  • has at least $1 million of assets under the management of the RIA; or

  • has a net worth (together, in the case of a client that is a natural person, with assets held jointly with a spouse) that the RIA reasonably believes to be in excess of $2.1 million.

On June 17, the Securities and Exchange Commission issued an order increasing the net-worth threshold from $2.1 million to $2.2 million and increasing the required assets-under-management threshold from $1 million to $1.1 million. Both increases are effective as of August 16. The increases in the net-worth and required assets-under-management thresholds are based on adjustments for inflation.

The change impacts performance fees charged to private funds that rely on Section 3(c)(1) of the Investment Company Act of 1940, as well as to separately managed accounts. RIAs who charge performance fees should revise applicable net-worth and assets-under-management representations in their investment advisory agreements and/or in their due diligence procedures and documentation. Additionally, RIAs should update their 3(c)(1) fund subscription agreements to reflect the updated thresholds for new separately managed account clients and 3(c)(1) fund investors.

However, Rule 205-3 specifically provides that existing investors and clients that no longer meet the new net-worth threshold can continue to be charged performance fees provided they met the net-worth threshold at the time they entered into the advisory contract under which they are charged such performance fees.

The SEC order is available here.

Christian B. Hennon, Richard D. Marshall, Fred M. Santo, Allison C. Yacker, Lance A. Zinman, and Elias B. Wright also contributed to this article.

©2022 Katten Muchin Rosenman LLPNational Law Review, Volume XI, Number 225

About this Author

David Y. Dickstein, Financial Services Lawyer, Katten muchin law firm

David Dickstein represents broker-dealers, investment advisers, investment companies and hedge funds in connection with a variety of regulatory, compliance and operational matters. David regularly counsels investment advisers on registration and regulatory matters, such as the need for registration, conflict of interest disclosures, soft dollars and best execution, firm advertising and marketing, federal and state pay-to-play matters, trade allocations and personal trading. He also advises broker-dealers on registration and ongoing compliance matters, mutual fund supermarkets...

Henry Bregstein, Katten Muchin Law Firm, Financial Institutions Legal Specialist

Henry Bregstein is the global co-chair of the firm’s Financial Services practice and a member of the firm’s Executive Committee and Board of Directors. In his role as partner in the Financial Services practice, he advises banks, domestic and offshore hedge funds, private equity funds, life insurance companies, family offices, sovereign wealth funds, investment advisers and broker-dealers on regulatory, securities, tax, finance, licensing, corporate and other legal matters.

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Wendy E. Cohen, Financial Services Lawyer, Katten Muchin Law firm

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Gary DeWaal, Securities Attorney, Katten Law Firm, New York
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Gary DeWaal focuses his practice on financial services regulatory matters. He counsels clients on the application of evolving regulatory requirements to existing businesses and structuring more effective compliance programs, as well as assists in defending and resolving regulatory disciplinary actions and enforcement matters. Gary also advises buy-side and sell-side clients, as well as trading facilities and clearing houses, on the developing laws and regulations related to cryptocurrencies and digital tokens.

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Mark Goldstein, Katten Law Firm, New York, Financial Law Attorney
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