SEC Issues Order Increasing the Net Worth Test Under Rule 205-3 Under the Investment Advisers Act of 1940 to $2.1 Million
Section 205(a)(1) of the Investment Advisers Act of 1940 (the "Advisers Act") generally prohibits an investment adviser from entering into, extending, renewing, or performing any investment advisory contract that provides for compensation to the adviser based on a share of capital gains on, or capital appreciation of, the funds of the client. Rule 205-3 under the Advisers Ac exempts an investment adviser from this prohibition in certain circumstances when the client is a "qualified client." The definition of "qualified client" includes an assets under management standard set as $1,00,000 and a net worth test that set at (in the case of a natural person, with assets held jointly with a spouse), more than $2,000,000.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) amended Section 205(e) of the Advisers Act to provide that, by July 21, 2011 and every five years thereafter, the SEC shall adjust for inflation the dollar amount thresholds included in rules issued under Section 205(e), rounded to the nearest $100,000. Rule 205-3 now states that the SEC will issue an order on or about May 1, 2016, and approximately every five years thereafter, adjusting for inflation the dollar amount thresholds of the rule's assets-under-management and net worth tests based on the Personal Consumption Expenditures Chain-Type Price Index (published by the United States Department of Commerce). Based upon this requirement, no change in the assets under management test is required, but the dollar amount of the net worth test would increase to $2,100,000.
Accordingly, on June 14, the SEC issued an Order, effective as of August 15, 2016, that:
i. for purposes of Rule 205-3(d)(1)(i) under the Advisers Act, a "qualified client" means a natural person who, or a company that, immediately after entering the contract has at least $1,000,000 under the management of the investment adviser; and
ii. for purposes of Rule 205-3(d)(1)(ii)(A) under the Advisers Act, a "qualified client" means a natural person who, or a company that, the investment adviser entering into the contract (and any person acting on his behalf) reasonably believes, immediately prior to entering into the contract, has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than $2,100,000.