Key Points

• The proposed order would increase the thresholds for permitting registered investment advisers to charge performance-based fees to a minimum net worth of $2.7 million (excluding the primary residence and certain related debt) or a minimum amount of assets under management with that registered investment adviser of $1.4 million.
• Subscriptions documents for private funds relying on Section 3(c)(1) of the Investment Company Act of 1940, as amended, and investment management agreements for certain separately managed accounts would need to be updated by the effective date of the proposed order (if issued) to reflect the new “qualified client” assets-under-management and net worth thresholds.

SEC’s Notice of Intent to Issue Order

On March 27, 2026, the Securities and Exchange Commission (SEC) issued a notice of intent to issue an order that would adjust for inflation the dollar amount thresholds to be a “qualified client” in Rule 205-3 under the Investment Advisers Act of 1940, as amended (the Advisers Act). Rule 205-3 a permits a registered investment adviser to charge performance-based fees only if the client (or deemed client) is a “qualified client,” which is defined by reference to minimum net worth (without looking to the value of the primary residence and excluding certain related debt) or a minimum dollar amount of assets under the management of the investment adviser. If the client is a private fund that relies on Section 3(c)(1) (a 3(c)(1) Fund) of the Investment Company Act of 1940, as amended (the Investment Company Act), an investment company registered under the Investment Company Act (a RIC) or a “business development company” (BDC), as defined in the Investment Company Act, each investor in that 3(c)(1) Fund, RIC or BDC would need to satisfy the qualified client test as if it were the client. Many states have also incorporated the qualified client test in Rule 205-3 under the Advisers Act into their exemptions from registration with the state for advisers to private funds and their own fee restrictions for advisers registered under those states.

Background

Section 205(a)(1) of the Advisers Act generally prohibits an investment adviser registered or required to be registered with the SEC from entering, extending, renewing, or performing any investment advisory contract that provides for compensation to the investment adviser based on a share of capital gains on or capital appreciation of, the funds of clients (performance fees). An SEC-registered investment adviser is permitted to receive performance fees from investors in hedge funds, private equity funds, other private funds, and separately managed account (SMA) clients, so long as those investors and clients are “qualified clients” under Rule 205-3 under the Advisers Act. “Qualified purchasers,” as defined in the Investment Company Act, and certain knowledgeable employees, officers and directors of the registered investment adviser are deemed to be qualified clients. In addition, under section 205(b)(5) of the Advisers Act, the prohibitions on charging performance-based fees do not apply to an investment advisory contract with a person who is not a resident of the United States.

The Dodd-Frank Wall Street Reform and Consumer Protection Act and Rule 205-3 requires the SEC to issue an order adjusting the dollar amount thresholds in Rule 205-3 for the effects of inflation every five years. The SEC last updated the income thresholds in Rule 205-3 on June 17, 2021, and therefore the SEC is required to amend the thresholds in 2026 and every five years thereafter.

New Thresholds

A qualified client is an investor or client that satisfies the below assets-under-management test or a net worth test:

• The threshold for assets under management by the investment adviser will increase from $1.1 million to $1.4 million.
• The investor or client net worth threshold (which includes spousal assets) will increase from $2.2 million to $2.7 million excluding the client’s or investor’s primary residence and related debt.

In general, only new investors and clients are affected by this change. Most existing fund investments and SMA arrangements are effectively grandfathered (for example, investors who previously invested in a 3(c)(1) fund and met a prior threshold can continue to make investments in that 3(c)(1) fund without meeting a new threshold).¹

The proposed order (which contains additional details) would, if issued, be effective 60 days following the order date. The proposed order is expected to be issued on or around May 1, 2026.

Next Steps Checklist

Registered investment advisers should consider the following steps:

• Amend the form subscription documents being used for 3(c)(1) Funds and other funds if any questionnaires or representations refer to any qualified client threshold amounts. Consider including both the old and the new threshold amounts until the effective date to permit advisers to accept new investors before the effective date using the old threshold amounts.
• Amend any forms for agreements with clients, such as separately managed account agreements, that provide for performance fees if they refer to any qualified client threshold amounts.
• Establish procedures with the investment adviser’s operations and investor relations teams, and with each fund administrator, to flag unamended subscription documents and SMA agreements that refer to any old, qualified client threshold amounts and to obtain updated qualified client representations.
• Consider referencing the above steps in the annual compliance review.

If you require assistance or have any questions regarding this alert, please feel free to reach out to your Akin relationship attorney or any of the authors.

^{1 See Investment Adviser Performance Compensation, Advisers Act Release 3372, 77 Fed. Reg. 10358 (Feb. 22, 2012) text at II.C available at https://www.govinfo.gov/content/pkg/FR-2012-02-22/pdf/2012-4046.pdf.}