Qualified client

A qualified client is an investor who meets specific wealth requirements under that allow investment advisers to charge them performance-based fees. These clients must have either $1.1 million in assets under management with the adviser or $2.2 million in net worth. The qualified client framework sets higher wealth requirements than standard thresholds because performance-based compensation creates potential conflicts of interest that require additional investor protection.

Investment advisers registered with the SEC generally cannot charge under of the Investment Advisers Act. Congress created this restriction because it worried that structures might encourage advisers to take excessive risks with client money. The qualified client exemption in Rule 205-3 provides a carefully designed exception that allows sophisticated investors to access performance fee arrangements while still maintaining important investor protections.

This regulatory approach assumes that investors who meet the qualified client wealth thresholds have enough financial resources and sophistication to understand and handle the risks that come with performance-based compensation. The tiered system reflects a graduated approach to protecting investors based on their wealth and assumed financial knowledge.

Rule 205-3 provides several ways to achieve qualified client status. The two main tests are having at least $1.1 million under management with the investment adviser or having a net worth that exceeds $2.2 million. Additional categories include under Investment Company Act definitions and certain employees or executives of the investment adviser who participate in investment activities.

When calculating net worth, the value of the investor's primary residence and any debt secured by that residence are excluded. This approach matches how accredited investor status is determined under Securities Act regulations. This consistent approach ensures harmony across federal securities law investor qualification standards, while keeping the qualified client threshold higher than basic accredited investor status.

The required that qualified client thresholds be adjusted periodically based on the . The SEC must review and adjust these thresholds approximately every five years, rounding to the nearest $100,000. The most recent adjustment took effect on August 16, 2021, raising thresholds from the previous levels of $1.0 million and $2.1 million respectively.

This systematic adjustment process ensures that qualified client standards maintain their intended restrictiveness over time. Without these adjustments, inflation would gradually expand access to performance fee arrangements beyond the investor population that regulators originally intended to include. The next scheduled review is expected around 2026.

The qualified client standard serves as a within the broader regulatory framework. While accredited investors can participate in most private fund offerings, only qualified clients can participate in performance fee arrangements with . Qualified purchasers represent an even higher threshold that is required for certain exemptions.

This tiered structure reflects regulatory recognition that different investment arrangements carry varying levels of risk. Performance fee structures create unique risk profiles that warrant higher than those required for basic participation.

Investment advisers must establish strong procedures for verifying and documenting qualified client status when contracts are signed. This ongoing compliance obligation requires advisers to maintain proper records and implement systems for tracking investor qualification status across their entire client base.

For domestic funds that rely on Investment Company Act exemptions, advisers must evaluate each underlying investor's qualified client status when charging performance fees. This creates additional compliance complexity for multi-investor fund structures compared to funds, which are treated as single clients for qualified client analysis.

protect existing contractual relationships that were entered into under previous threshold levels. However, new investors or additional commitments from existing investors must meet current standards. This balances the need for current regulatory standards with contractual stability for established adviser-client relationships.