Regulatory Update: SEC Raises Qualified Client Thresholds

Effective August 16, 2021, there will be new thresholds for determining whether an investor of a registered investment adviser is a “qualified client” under Rule 205-3 of the Investment Advisers Act of 1940 and thus can be charged incentive compensation (i.e., performance fees, allocations, or other forms of carry). A “qualified client” is an investor that satisfies an assets-under-management test or net worth test. The amendment will primarily affect private funds relying on the 3(c)(1) exemption, but 3(c)(7) funds should also review their documents to ensure the “qualified client” representations are updated accordingly. State registered investment advisers that incorporate the definition of “qualified client” into their documents may also be affected by these changes.

On August 16, 2021, the threshold will be increased as follows:

  • The threshold for investor assets under management with the adviser will increase from $1 million to $1.1 million.
     
  • The investor net worth threshold (which includes spousal assets) will increase from $2.1 million to $2.2 million, excluding the investor’s primary residence and related debt.

Only new investors or existing investors that are making new commitments are affected by this change. Most existing fund investments and Separately Managed Account (“SMA”) arrangements are grandfathered. Therefore, the agreements entered into before August 16, 2021, should not need to be amended.

What Actions Are Required

Registered investment advisers should consider the following action points:

  • Amend the subscription documents being used by 3(c)(1) funds.
  • Amend any SMA agreements that provide incentive compensation.
  • Review the subscription documents for non-3(c)(1) funds and amend any qualified client representations.
  • Ensure the Investor Relations team has the updated subscription documents and there are controls in place to decommission the former documents.
  • Make note of the actions taken in the annual compliance review.

The SEC’s order issuing these changes can be viewed here.

 

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Our team has a proven track record in assisting private fund managers with a comprehensive spectrum of compliance and regulatory services ranging from ongoing and project-based offerings to the development and execution of entire compliance programs. We take pride in our ability to deliver solutions required by our clients to support their compliance infrastructure in an ever-evolving industry. Should you require our expert team to answer questions regarding the amendments to the qualified client thresholds or on any of our services, we would be delighted to speak with you. Please reach out to Daryoush Niknejad or Michael Barakat directly.