SEC Raises "Qualified Client" Thresholds Under Rule 205-3

The SEC has issued an order adjusting for inflation the dollar amount thresholds for qualified client status under Rule 205-3 of the Investment Advisers Act of 1940 (Advisers Act), which takes effect on June 29, 2026.¹ The Dodd-Frank Act requires the SEC to make this adjustment every five years, and the latest order reflects inflation from 2021 through the end of 2025.

Background

Section 205(a)(1) of the Advisers Act generally prohibits registered investment advisers (RIAs)² from charging performance fees unless the client is a qualified client, as defined in Rule 205-3. A client qualifies through either having 1) at least a specified dollar amount of assets under management with the RIA immediately after entering the advisory contract³ or 2) a specified net worth test (including spousal assets, but excluding a primary residence and related indebtedness).⁴ Qualified purchasers and certain "knowledgeable employees" of an RIA are deemed qualified clients regardless of these dollar amounts.⁵ In addition, non-U.S. residents are not subject to this restriction.

Although a private fund managed by an RIA is considered the "client" for purposes of the Advisers Act, not the fund's investors, Rule 205-3 looks through private funds that rely on Section 3(c)(1) of the Investment Company Act of 1940 (in addition to registered investment companies and business development companies) and applies the qualified client limitation to the investors in such vehicles – i.e., an RIA that advises such a vehicle cannot charge performance fees if any investor does not meet the qualified client definition.⁶ Thus, the qualified client thresholds are most relevant for RIAs that charge performance fees and advise Section 3(c)(1) funds or separately managed accounts.

New Thresholds

The new thresholds apply to contracts and fund subscriptions entered into on or after June 29, 2026. Existing arrangements are generally grandfathered, though the new thresholds will apply to any new investor or new party that joins an existing arrangement on or after the effective date.

Action Items

RIAs should consider taking the following steps before June 29, 2026:

• Update Subscription Documents. Amend questionnaires and investor representations for Section 3(c)(1) funds to reflect the new qualified client thresholds. Consider including both the current and new thresholds until the effective date to accommodate closings on either side of such date.
• Amend Managed Account Agreements. Update any investment management agreements that provide for performance fees and reference the specific qualified client dollar amounts.
• Assess Pending Closings and Transfers. Consider any pending closings for Section 3(c)(1) funds and review any in-process LP transfers for compliance with the new thresholds.
• Update Compliance Documentation. Review and revise compliance policies and procedures, private placement guidelines, marketing materials and training materials that reference the prior thresholds.

For questions about how these changes affect your fund documentation, advisory arrangements or compliance program, please contact your Holland & Knight relationship attorney.

Notes

¹ See Order Approving Adjustment for Inflation of the Dollar Amount Tests in Rule 205-3 under the Investment Advisers Act of 1940, SEC Rel. No. IA-6961 (April 28, 2026).

² Though Section 205(a)(1) and Rule 205-3 apply only to investment advisers registered with the SEC, the laws of many states incorporate by reference the "qualified client" standard under Rule 205-3 in applying certain state-level investment adviser registration exemptions and other requirements.

³ Assets under management is calculated as the total of 1) uncalled capital commitments plus 2) the gross asset value or fair value of existing investments managed by the adviser.

⁴ See Rule 205-3(d)(1)(ii)(A) under the Advisers Act.

⁵ See Section 205(b)(5) of the Advisers Act; Rule 205-3(d)(1)(ii)(B) and (iii) under the Advisers Act.

⁶ Note that the performance fee limitation applies on an indirect basis as well. For example, if a Section 3(c)(1) fund invests in another Section 3(c)(1) fund, all investors in the investing fund must be qualified clients for the underlying fund's RIA manager to charge a performance fee to the underlying fund. Advisers should confirm that their subscription agreements include adequate screens to identify such participation.