SEC Final Order Increasing "Qualified Client" Thresholds Under Rule 205-3 of the Investment Advisers Act
On April 28, 2026, the Securities and Exchange Commission (“SEC”) issued a final order adjusting for inflation the thresholds required to qualify as a "qualified client" under Rule 205-3 of the Investment Advisers Act of 1940, as amended (the "Advisers Act"). The new thresholds take effect on June 29, 2026, and will require updates to subscription documents for certain private funds and investment management agreements for separately managed accounts which provide for performance-based compensation. This alert highlights the key changes, who is affected, and certain practical next steps.
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 into, extending, renewing, or performing any investment advisory contract that provides for performance-based fees. However, under Rule 205-3, an adviser is permitted to charge performance-based fees to clients (or deemed clients) who meet the definition of a "qualified client." A client or investor qualifies by meeting either a minimum net-worth test or an assets-under-management test with the adviser. SEC-registered advisers, this framework applies to both (x) investors in certain private funds managed by such advisers and (y) SMA clients of such advisers.
For private funds relying on Section 3(c)(1) under the Investment Company Act of 1940, as amended, each investor must independently satisfy the “qualified client” test; although certain categories of investors, such as qualified purchasers and knowledgeable employees, are deemed to be “qualified clients.” The prohibition on performance-based fees does not apply to non-U.S. residents; however, notably, certain individual states often incorporate the federal standard in such states’ applicable exempt reporting adviser (“ERA”) requirements.
New Qualified Client Thresholds
Effective June 29, 2026, the new “qualified client” thresholds increase as set forth below. New investors and SMA clients must meet one of the two threshold tests as follows:
Assets-Under-Management Test. The minimum amount of assets under the management of the registered investment adviser increases from $1.1 million to $1.4 million (the “AUM Test”). For the AUM Test, assets are calculated as uncalled capital commitments plus the gross asset value or fair value of investments managed by the adviser.
Net Worth Test. The minimum net worth requirement increases from $2.2 million to $2.7 million (the “Net Worth Test”). The minimum net worth calculation includes spousal assets but excludes the client's or investor's primary residence and related debt.
Applicability and Grandfathering
The foregoing changes generally apply only to new clients, new investors and new investments made by existing investors in private funds managed by SEC-registered investment advisers. Existing fund commitments and most SMA arrangements are effectively grandfathered, so additional contributions under an existing commitment typically do not require retesting. The current (lower) thresholds may be used until June 28, 2026; the updated thresholds apply to advisory contracts and private fund subscriptions entered into on or after June 29, 2026.
Considerations for Exempt Reporting Advisers and State Law (including California)
Many ERAs rely on state private-fund adviser exemptions that reference the federal “qualified-client” standard. Where a state incorporates Rule 205-3 of the Advisers Act, the June 29, 2026 increases may become gating criteria for fund subscriptions advised by ERAs.
For example, California conditions its private-fund adviser exemption for 3(c)(1) funds on all investors being “qualified clients” under Rule 205-3 under the Advisers Act. Absent another exemption (e.g., 3(c)(7) “qualified purchaser” funds or a venture-capital adviser exemption), ERAs should apply the $1.4 million AUM Test and the $2.7 million Net Worth Test to new subscriptions on and after June 29, 2026.
Other states take a similar approach, though details vary from the NASAA model. ERAs should confirm each applicable state’s exemption test, including any carve-outs or effective-date mechanics for adopting federal adjustments.
Practical Next Steps
Update Subscription Documents. Advisers should amend the form subscription documents being used for 3(c)(1) funds and any other funds if any questionnaires or representations refer to “qualified client” threshold amounts. Advisers may consider including both the old and new threshold amounts in subscription documents until June 29, 2026, to permit acceptance of new investors before the effective date using the old threshold amounts.
Amend Client Agreements. Advisers should amend any form agreements with clients, such as separately managed account agreements, that provide for performance-based fees, if they refer to any “qualified client” threshold amounts.
Establish Operational Procedures. Advisers should establish procedures with their operations and/or investor relations teams, as well as with each fund administrator, to (x) flag unamended subscription documents and SMA agreements that refer to the old “qualified client” threshold amounts and (y) obtain updated “qualified client” representations.
Annual Compliance Review. Advisers should consider referencing the above steps in their annual compliance review.
Conclusion
These inflation adjustments to the “qualified client” thresholds require timely updates to documents and processes before the June 29, 2026 effective date. Please review subscription documents, advisory agreements, and compliance procedures to ensure alignment.
Please contact us with any questions regarding how these changes affect your business.
