Updated “Qualified Client” Inflation Adjusted Thresholds

On April 28, 2026, the U.S. Securities and Exchange Commission (the “SEC”) issued an order (the “Order”) adjusting for inflation the dollar-amount thresholds referenced in the definition of “qualified client” under Rule 205‑3 of the Investment Advisers Act of 1940, as amended (the “Advisers Act”).[1] These dollar-amount thresholds govern when an investment adviser registered with the SEC may charge performance-based compensation (including carried interest and performance allocations) to a client account.

Under the recent Order:

• The Assets-under-Management (“AUM”) test threshold has been raised from $1,100,000 to $1,400,000; and
• The net-worth test threshold has been raised from $2,200,000 to $2,700,000.

These changes reflect the SEC’s obligation under Section 205(e) of the Advisers Act, as amended by the Dodd‑Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), to adjust the “qualified client” thresholds for inflation every five years. The Order was published in the Federal Register on May 1, 2026.

The Order has an effective date of June 29, 2026. Investment advisory contracts and private fund offerings entered into prior to the effective date may continue to rely on the prior thresholds, subject to the transition rules provided in Rule 205‑3.

BACKGROUND

Section 205(a)(1) of the Advisers Act prohibits an investment adviser from entering, extending, renewing, or performing any investment advisory contract that provides compensation based on a share of capital gains on, or capital appreciation of, the funds of a client, except in limited circumstances. This prohibition is designed to protect advisory clients from fee structures that could incentivize investment advisers to take excessive risk.

Congress authorized the SEC, through Section 205(e) of the Advisers Act, to exempt investment advisers from this prohibition where the client is sufficiently sophisticated and financially able to bear the risks associated with performance-based compensation. Rule 205‑3 under the Advisers Act implements this authority by permitting an investment adviser to charge performance-based compensation to “qualified clients,” defined in part by reference to specified asset or net-worth thresholds. Pursuant to Section 205(e) of the Advisers Act and the Dodd‑Frank Act, the SEC is required, every five years, to adjust these dollar thresholds for inflation, rounded to the nearest multiple of $100,000, to ensure that the “qualified client” category remains appropriately targeted over time. The most recent Order implements the next scheduled inflation adjustment.

A client is a “qualified client” if, at the time the advisory contract is entered into, renewed, or extended, the client meets one of the following financial tests, among other criteria set forth in Rule 205‑3:

• AUM test – The client has at least a specified minimum dollar amount of AUM with the investment adviser after entering the advisory contract;[2] or
• Net-worth test – The investment adviser reasonably believes that the client has a net worth above a specified minimum dollar amount at the time the advisory contract is entered into.[3]

As a result of these adjustments, clients and investors who met the “qualified client” standard under the former thresholds—but who do not meet the updated thresholds—will not qualify as “qualified clients” for purposes of new advisory contracts entered into, or new interests in private funds acquired, on or after the effective date. Existing advisory contracts and fund interests that satisfied the prior thresholds remain grandfathered under the transition rules.

WHO IS AFFECTED BY THE UPDATED THRESHOLDS

The updated “qualified client” thresholds will principally affect:

• Private fund managers (including managers of hedge funds, private equity funds, venture capital funds that charge performance fees, and other pooled investment vehicles) who rely on Rule 205‑3 to charge performance allocations or incentive fees to investors.
• Investment advisers registered under the Advisers Act who wish to charge performance-based compensation to advisory clients and rely on the “qualified client” exemption.
• New investors and clients admitted or onboarded on or after the Order’s effective date who must satisfy the updated thresholds to be subject to performance-based compensation under Rule 205‑3.

In general, the transition provisions in Rule 205‑3 permit investment advisers to continue charging performance-based compensation pursuant to advisory contracts and private fund arrangements that satisfied the “qualified client” conditions in effect at the time those contracts were entered into. However, when a new investor (including a new equity owner of a private fund or similar pooled vehicle) is admitted after the effective date, or when an existing investor increases its interest after the effective date, the investment adviser will need to apply the updated thresholds to that investor with respect to such new or additional investment.

Investment advisers should also consider the interplay of these changes with other regulatory and investor eligibility standards, including “accredited investor” and “qualified purchaser” definitions (under, respectively, the U.S. Securities Act of 1933, as amended, and the U.S. Investment Company Act of 1940, as amended) which are separate concepts and are not altered by the recent Order, but often appear in the same subscription and onboarding processes.

RECOMMENDED NEXT STEPS FOR PRIVATE FUND MANAGERS AND OTHER INVESTMENT ADVISERS

Private fund managers and other investment advisers relying on the “qualified client” standard should consider taking the following steps in advance of, and following, the effective date of the new thresholds:

Review Existing Fund and Advisory Contracts That May Accept New Capital

• For private funds that are still in their fundraising period or that may accept additional capital contributions, and for advisory arrangements that may be renewed or extended, identify which arrangements rely on Rule 205-3 to charge performance fees or performance allocations.
• Confirm which investor interests or advisory contracts will be entered into, renewed, or extended after the effective date and thus may be subject to the updated thresholds.

Update Subscription Agreements and Investor Questionnaires

• Revise subscription documents for private funds, including investor qualification sections, to reflect the new thresholds for assets-under-management ($1,400,000) and net-worth ($2,700,000).
• Align related representations, warranties, and investor questionnaires with the updated definition of “qualified client.”
• Consider adding explanatory disclosures distinguishing “qualified client” status from other regulatory status tests (e.g., accredited investor, qualified purchaser).

Revise Advisory Agreements and Performance Fee Provisions

• Update form investment advisory agreements for advisory clients to incorporate the new thresholds where performance-based compensation is contemplated.
• Consider drafting contractual provisions that expressly condition the investment adviser’s right to charge performance fees on the client’s satisfaction of the “qualified client” requirements in effect at the time of entry into the contract.

Review and Enhance Onboarding and Compliance Procedures

• Update internal checklists, compliance manuals, and onboarding procedures to incorporate the revised “qualified client” thresholds and effective date.
• Ensure that personnel responsible for investor onboarding and client intake (including investor relations, operations, and compliance) are informed of the new thresholds and related documentation changes.
• Confirm that systems used to capture and store investor eligibility information (including digital subscription platforms) are updated to apply the new thresholds.

CONCLUSION

The SEC’s latest inflation adjustment to the “qualified client” thresholds under Rule 205‑3 materially increases the minimum asset and net-worth levels that clients and private fund investors must meet to be charged performance-based compensation. Private fund managers and other investment advisers registered under the Advisers Act should promptly review and, where necessary, update their subscription agreements, advisory contracts, disclosure documents, and internal compliance procedures to ensure that, for new investors and new advisory relationships, performance-based compensation is charged only where the investor or client satisfies the updated “qualified client” definition. Please do not hesitate to contact a member of our Investment Funds team with any questions about how the updated thresholds may affect your firm’s advisory services, including private funds that you manage.

[1] Order Approving Adjustment for Inflation of the Dollar Amount Tests in Rule 205‑3 Under the Investment Advisers Act of 1940, Investment Advisers Act Release No. IA-6961 (Apr. 28, 2026), 91 Fed. Reg. 23520 (May 1, 2026).

[2] See Rule 205-3(d)(1)(i) under the Advisers Act.

[3] See Rule 205-3(d)(1)(ii)(A) under the Advisers Act.