On April 28, 2026, the Securities and Exchange Commission (SEC) issued a final order adjusting for inflation the dollar amount thresholds used to determine whether an investor qualifies as a “qualified client” in order to charge a performance fee in reliance on Rule 205-3 under the Investment Advisers Act of 1940 (the Final Order).
The new thresholds take effect on June 29, 2026, and carry immediate practical implications for registered investment advisers, private fund sponsors and their investors.
Why It Matters
Section 205(a)(1) of the Advisers Act generally prohibits an investment adviser from charging fees based on a share of capital gains on, or capital appreciation of, a client’s account (commonly referred to as “performance fees” or “incentive fees”). Rule 205-3 under the Advisers Act provides a critical exemption. It allows an adviser to charge performance fees or incentive fees only if the client is a “qualified client,” which turns on either a minimum amount of assets managed by the adviser or a minimum net worth (excluding the value of the client’s primary residence and certain related debt). In the case of a client that is a private fund relying on Section 3(c)(1) of the Investment Company Act of 1940 (ICA), an investment company registered under the ICA, or a business development company, the adviser must “look through” the legal entity to determine whether each equity owner of the company would be a “qualified client.”[1]
Importantly, certain investors and clients are deemed to be “qualified clients” or are otherwise outside the scope of Section 205(a)(1), including “qualified purchasers” as defined in Section 2(a)(51)(A) of the ICA, “knowledgeable employees,”[2] officers and directors of the investment adviser, andpersons who are not residents of the United States.[3]
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 requires the SEC to adjust these dollar amount thresholds for inflation every 5 years. The SEC last updated the thresholds on June 17, 2021, and was, therefore, required to revisit them in 2026.
The New Thresholds
Effective June 29, 2026, the new “qualified client” thresholds are as follows:
- Assets-Under-Management Test. The minimum amount of assets under the management of the investment adviser increases from $1.1 million to $1.4 million.
- Net Worth Test. The minimum net worth threshold (which includes spousal assets but excludes the primary residence and related debt) increases from $2.2 million to $2.7 million.
Grandfathering and Transition
Importantly, the new thresholds apply only to new investment advisory contracts entered into on or after June 29, 2026, the effective date. In other words, the new thresholds do not apply to investments by clients and investors who met the definition of “qualified client” at the time but do not subsequently meet the definition. Most existing fund investments and separately managed account (SMA) arrangements are effectively grandfathered. For example, investors who previously invested in a Section 3(c)(1) fund and met a prior qualified client threshold may continue to make investments in that same fund without needing to satisfy the new, higher thresholds. This approach is consistent with the longstanding transition framework in Rule 205-3, which is designed to minimize disruption to existing contractual relationships that met applicable requirements at the time the parties entered into them.
What Advisers Should Do
Advisers should consider the following steps:
- Amend subscription documents for Section 3(c)(1) funds and other funds if any questionnaires or representations reference the current “qualified client” threshold amounts. Advisers may wish to include both the old and new thresholds in their forms until June 29, 2026, to permit acceptance of new investors under the existing thresholds before the effective date.
- Amend investment management agreements for separately managed accounts and other client arrangements providing for performance fees and incentive fees, to the extent they reference the current threshold amounts.
- Coordinate with operations, investor relations, and fund administrators to flag unamended subscription documents and SMA agreements that still reference the old thresholds, and to obtain updated qualified client representations from new investors.
- Incorporate the above steps into the annual compliance review to ensure ongoing compliance.
Looking Ahead
The inflation adjustment mechanism embedded in the Dodd-Frank Act ensures that the qualified client thresholds will continue to rise over time, with the next adjustment due on or about May 1, 2031.
For more information about the SEC’s updated qualified client thresholds and how these developments may impact your fund documentation and compliance programs, please contact the authors of this article or your primary Katten attorney.
[1] Under this provision, each “tier” of such entities must be examined in this manner. Thus, if a 3(c)(1) fund seeking to enter into a performance fee contract (the first tier company) is owned by another 3(c)(1) fund (the second tier company), the look through provision applies to the second (and any other) level 3(c)(1), and thus the adviser must look to the ultimate client to determine whether the arrangement satisfies the requirements of the rule. Further, any “equity owners” that are not charged a performance fee or incentive fee would not be required to meet the “qualified client” test.
[2] “Knowledgeable Employee” is defined in Rule 3c-5 under the Advisers Act to include executive officers, directors, trustees, general partners, and advisory board members of a section 3(c)(1) or a section 3(c)(7) private fund, and those who serve in similar capacities. Rule 3c-5 also includes certain other employees of the fund or its management affiliate who participate in investment activities and have performed such functions for at least 12 months.
