In a Guidance Update published this week, the SEC’s Division of Investment Management said that it would not object if related investment advisors registered jointly with the SEC and operating a single advisory business aggregate investments made by certain investors for purposes of determining if those investors are “qualified clients.”
The question comes up in the context of Rule 205-3 under the Advisers Act, which provides an exemption from the prohibition on charging advisory clients compensation based on a share of capital gains upon or capital appreciation of a client’s funds. Under Rule 205-3, an investment adviser may charge such performance-based compensation if a client, including a private fund investor, is a “qualified client.” Among other things, an investor is a qualified client if “immediately after entering into the contract [it] has at least $1,000,000 under the management of the investment adviser,” or has a net worth of more than $2 million.
Certain investment advisory firms formed as separate legal entities but operating a “single advisory business” through related investment advisers register jointly with the SEC in reliance on a 2012 staff no-action position issued to the American Bar Association. In some cases, related investment advisers collectively advise two or more different private funds in which the same client may invest. These related advisers sought clarification of whether, for purposes of Rule 205-3, they may aggregate a client’s investment in all of the private funds advised by related investment advisers. The SEC staff said that it would not object to aggregating such investments to determine if a client has at least $1,000,000 “under the management of the investment adviser” and thus is a qualified client.
This guidance is a welcome development for related advisers to private funds that otherwise faced uncertainty about whether they could charge performance fees to certain clients or must decline to accept that client’s investment in a fund. It is also welcome that the staff is proactively addressing its views on developing best practices for private fund advisers that registered with the SEC subsequent to the passage of the Dodd-Frank Act.