Rule 205-3 issued under the Investment Advisers Act of 1940, or the Advisers Act, provides an exemption from section 205(a)(1) of the Advisers Act, which prohibits an investment adviser from entering into an investment advisory contract that provides for compensation to the adviser on the basis of a share of capital gains upon or capital appreciation of the client’s funds.  An investment adviser may charge such a fee under rule 205-3 if the client—including investors in certain private funds—is a “qualified client” as defined in the rule. An investor is a qualified client if, among other ways to qualify, the investor, “immediately after entering into the contract has at least $1,000,000 under the management of the investment adviser.”

The SEC has been asked whether advisers may aggregate the investments of certain investors when determining whether the investors are qualified clients as defined in rule 205-3.  In these cases the related investment advisers that comprise a firm collectively advise two or more different private funds, each with its own investors. When determining if an investor is a qualified client as defined in rule 205-3 and is therefore eligible to be charged performance-based compensation, firms have asked whether they may aggregate the investor’s investments in all of the private funds advised by the related investment advisers that comprise the firm. An investor may have invested less than $1,000,000 in any one private fund, but more than $1,000,000 collectively in the private funds advised by the related investment advisers that comprise the firm. In this situation, consistent with the operation of a single advisory business as described in the no-action letter to the American Bar Association, the staff would not object if the firm aggregated the investor’s investments in all of the private funds advised by the related investment advisers that comprise the Firm when determining if the investor has at least $1,000,000 “under the management of the investment adviser,” and thus is a qualified client as defined in rule 205-3.