Effective August 15, 2016, the Securities and Exchange Commission (the SEC) is adjusting the dollar amount of the net worth test set forth in Rule 205-3 under the Investment Advisers Act of 1940 (the Advisers Act) from $2,000,000 to $2,100,000.
Rule 205-3 provides an exception to the general prohibition on advisers receiving performance-based compensation (including carried interest and other incentive allocations) where a contract is between the adviser and a “qualified client.” Under the current version of the rule, a client with a net worth of more than $2,000,000 is considered a “qualified client.” The SEC has used its authority under the Advisers Act to increase this figure by $100,000. Although the increased amount will apply as of August 15, 2016, existing advisory arrangements that were entered into prior to this date will generally be unaffected. The SEC also determined to leave the “assets under management” component of the “qualified client” definition unchanged at $1,000,000.
Many private fund sponsors already limit their investor base to persons who are “qualified purchasers” in accordance with Section 3(c)(7) of the Investment Company Act of 1940 (the Investment Company Act). Rule 205-3 provides that investors who are “qualified purchasers” will also be treated as “qualified clients.” Therefore, the change to the net worth test generally will not impact 3(c)(7) funds. However, the change could affect advisory arrangements with private funds that rely on Section 3(c)(1) of the Investment Company Act as well as separately managed accounts, among others.