New Qualified Client Definition Effective September 19, 2011

The Dodd-Frank Act required the SEC to revise upward the dollar thresholds for a person to be deemed a “qualified client” pursuant to Rule 205-3. The qualified client definition is important because SEC registered investment advisers (including hedge fund managers) cannot charge performance fees to those investors who are not qualified clients. Previously an individual needed to have a net worth of $1.5 million or have $750,000 of AUM with the investment adviser. The new thresholds are $2 million and $1 million respectively.

It does not appear that there are any grandfathering provisions that will be applicable and it is currently unclear whether managers will need to seek confirmation from current investors/clients as to whether such investors meet the new qualified client definition. If managers are required to seek additional confirmation from current investors, this will obviously create additional legal and administrative expenses for managers. Regardless, for any future investors/clients, SEC registered investment

advisers (and those groups that will be registering within the next 9 months) should make sure that the new qualified client definition is included in all subscription documents and other investment advisory contracts.

Another important issue is how this change will affect state registered investment advisers. Many state laws and regulations either mirror the federal laws and regulations or make specific reference to Rule 205-3. It is likely that many states will be coming out with guidance on this issue either through notifications or orders, or through legislative changes. Nonetheless, most state registered investment advisers should begin making plans to adapt to the changes at the federal level.

As more information from the states become available, we will be providing updates on this blog.

The notice of the SEC order is reprinted below and can be found here.

The actual SEC Order can be found here: SEC Order – Qualified Client Definition

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SEC Issues Order Raising Performance Fee Rule Dollar Limit to Adjust for Inflation

FOR IMMEDIATE RELEASE

2011-145

Washington, D.C., July 12, 2011 – The Securities and Exchange Commission today issued an order that raises, to adjust for inflation, two of the thresholds that determine whether an investment adviser can charge its clients performance fees. The order carries out a requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

SEC's Order

Rule 205-3 under the Investment Advisers Act allows an investment adviser to charge a client performance fees if the client meets certain criteria, including two tests that have dollar amount thresholds. Under today’s order, an investment adviser will be able to charge performance fees if the client has at least $1 million under the management of the adviser, or if the client has a net worth of more than $2 million. Either of these tests must be met at the time of entering into the advisory contract. The previous thresholds were $750,000 and $1.5 million respectively, and were last revised in 1998.

The Dodd-Frank Act requires that the Commission issue an order to adjust for inflation these dollar amount thresholds by July 21, 2011 and every five years thereafter. The Commission published a notice of its intent to issue the order on May 10, 2011. The Commission also proposed amendments to rule 205-3, which are currently under consideration.

The order will be effective on September 19, 2011, which will be approximately 60 days after its publication in the Federal Register.

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Bart Mallon is an attorney with a practice focused on hedge funds and investment adviser registration. He can be reached directly at 415-868-5345.