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Change to Definition of “Qualified Client” Takes Effect

By Robert D. Conca, Partner  of Shustak Reynolds & Partners, P.C. posted on Tuesday, August 17, 2021.

Robert D. Conca

Robert D. Conca

Partner

Location: San Diego, California
Phone: (619) 696-9500 (Ext. 121)
E-mail
[email protected]

Investor sophistication standards are critical for hedge funds, private equity funds and other advisory firms that use performance-based compensation agreements.  The “accredited investor” standard is the most familiar, but the “qualified client” standard is more important when a firm charges a fee based on investment profits.

Section 205(a)(1) of the Investment Advisers Act of 1940, as amended (“Advisers Act”) generally permits [1] an investment adviser to charge a performance fee (aka incentive allocation or carried interest) if a client or an investor meets the definition of “qualified client”.

On August 16, 2021, the definition for “qualified client” changed so that the two primary tests to qualify for this standard increased by $100,000 each:[2] 

1. Under the "assets under management" test, a natural person or company will be considered a "qualified client" if that investor has $1,100,000 under management with an investment advisor.

2. Under the "net worth" test, an investment advisor needs to have a reasonable belief that a natural person (including the jointy-held assets of a spouse) or company has a net worth of more than $2,100,000 immediately prior to entering into contract. 

This change stems from the Dodd-Frank Wall Street Reform and Consumer Protection Act which amended the Advisers Act [3] to require an amendment to the two tests described above every five years to adjust for inflation.

Most investment advisers and fund managers that enter performance fee arrangements after August 16, 2021 will need to take extras steps to ensure clients and investors meet the new standards.  It is likely that updates to contracts and related policies and procedures will be necessary as well. 

Advisers need to make regulatory compliance a priority.  We can help.

Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes.
We represent many broker-dealers, registered representatives, investment advisors, investors and businesses.
Attorney Robert D. Conca can be reached in the firm’s San Diego office at (619) 696-9500.



[1] More precisely, the statute exempts the adviser from the restriction against charging a performance fee.

[2] There are ways other than the two primary tests whereby one may qualify as a “qualified client”.  See Advisers Act Rule 205-3(d)(1), available here

[3] See the SEC Order here.

 

 

 

 
 
 

 

 

 

 

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