Alert July 19, 2011

SEC Issues Order Increasing “Qualified Client” Income and Net Worth Thresholds for Performance-Based Advisory Fees

The SEC issued an order that increases two dollar amount thresholds in Rule 205-3 under the Investment Advisers Act of 1940 related to “qualified client” status; the Rule permits a registered adviser to charge a qualified client, i.e., one that meets one or the other of these thresholds (or satisfies alternative criteria under the Rule) a fee based on a share of capital gains on, or capital appreciation of, the client’s account (a “performance fee”).  Currently, under the two tests in question, a client may be a qualified client either by (a) having $750,000 under the management with an adviser immediately after entering into the advisory contract under which a performance fee will be charged or (b) having a net worth of $1.5 million immediately prior to entering into the advisory contract under which a performance fee will be charged.  The order, which effects a mandate under the Dodd‑Frank Act, increases those amounts to $1 million and $2 million, respectively, effective September 19, 2011.  The SEC continues to consider a related proposal to amend Rule 205‑3 that would effect the remainder of the Dodd-Frank Act’s mandate in this area by providing that the SEC may issue an order every five years that adjusts the assets under management and net worth tests for inflation.  Although not mandated by the Dodd‑Frank Act, the rule proposal would also (a) exclude the value of a primary residence, and related debt up to the current market value of the residence, from the qualified client net worth calculation and (b) revise the Rule’s transition provision to grandfather fee arrangements that were compliant with the Rule’s conditions (if applicable) at the time a client and adviser entered into the arrangements.  For more on the proposed amendments, see the May 18, 2011 Financial Services Alert.