Qualified purchaser

The qualified purchaser standard was created by the National Securities Markets Improvement Act of 1996Federal legislation that created the qualified purchaser standard and Section 3(c)(7) exemption for private funds.. This law established the Section 3(c)(7) exemption from Investment Company Act registration. The qualified purchaser standard sets a much higher wealth threshold than the accredited investor Accredited investor An accredited investor refers to an individual or entity that meets specific financial thresholds set by securities regulations, qualifying them to invest in unregistered securities offerings such as hedge funds, with standards including minimum income or net worth requirements. requirement. This effectively limits 3(c)(7) fundsPrivate investment funds that rely on the Section 3(c)(7) exemption from Investment Company Act registration by limiting investors to qualified purchasers. to sophisticated institutional investors and ultra-high-net-worth individualsInvestors with extremely high levels of investable assets, typically exceeding $30 million in net worth..

The qualified purchaser designation works differently from the accredited investor standard in two key ways: threshold amounts and measurement criteria. Accredited investors qualify based on income levels or net worth that includes real estate. Qualified purchasers, however, must demonstrate much higher levels of actual investment holdings. Their primary residences and business assets don't count toward the qualification.

The Investment Company Act defines qualified purchasers across several distinct categories. Each category has different threshold requirements. Individual natural persons qualify by owning at least $5 million in investments. Family companies may also qualify when they own at least $5 million in investments and maintain direct or indirect ownership by two or more related natural persons. These related persons include siblings, spouses, lineal descendants, or entities established for their benefit.

For larger institutional participants, the rules are different. Any person acting for their own account or for other qualified purchasers qualifies when they own and invest on a discretionary basis at least $25 million in investments. However, there's an important caveat: they must not have been formed specifically to acquire the securities being offered.

The qualified purchaser definition focuses specifically on "investments" rather than net worth or total assets. This creates a narrow and precise qualification standard. The SEC has provided detailed guidance on what counts as investments. Generally, investments include securities, real estate held for investment purposes, cash equivalents, and certain commodity interests. However, several major assets are explicitly excluded: primary residences, personal-use property, and assets used in trade or business.

This investment-focused approach ensures that qualification reflects actual investment sophistication and market participation. It's not just about general wealth accumulation. The distinction becomes particularly important for high-net-worth individuals whose wealth may be concentrated in non-investment assets such as primary residences or operating businesses.

Trust structures present unique qualification challenges that require careful analysis of trustee and settlor status. For trusts not formed specifically for acquiring Section 3(c)(7) fund interests, both the trustee responsible for investment decisions and each settlorThe person who creates a trust by transferring assets to it, also known as the grantor or trustor. must qualify as qualified purchasers. The SEC evaluates trustee qualification at the time investment decisions are made. Settlor status is determined when assets are contributed to the trust.

When multiple trustees exist, only the trustee with investment decision-making authority needs to qualify as a qualified purchaser. Irrevocable trustsTrust structures where the settlor cannot modify or terminate the trust after its creation, often used for tax and estate planning purposes. cannot qualify solely based on beneficiary status. This is true even when all beneficiaries are qualified purchasers, unless the trustee and settlor also meet the requirements.

Investment advisers and fund managers need only maintain a "reasonable belief" that investors qualify as qualified purchasers at each investment date. They don't need to conduct exhaustive verification procedures. This reasonable belief standard allows reliance on investor representations in subscription agreements and periodic confirmations of continued qualification.

Fund documentation typically requires general partner consent for interest transfers. This ensures appropriate qualified purchaser representations from transferees. Alternatively, funds may restrict transfers exclusively to persons meeting qualified purchaser requirements. This maintains compliance through structural limitations rather than case-by-case verification.

The qualified purchaser standard enables 3(c)(7) funds to accept unlimited numbers of investors. This is unlike the 100-investor limitation that constrains Section 3(c)(1) funds. This flexibility has proven crucial for institutional-focused hedge funds seeking to scale beyond traditional constraints while maintaining Investment Company Act exemption status.

However, practical considerations exist. Exchange Act reporting requirementsSecurities Exchange Act provisions requiring public disclosure of financial information and ownership stakes above certain thresholds. may be triggered at 2,000 investors. There's also possible publicly traded partnershipA partnership whose interests are traded on a securities exchange or in a secondary market, subject to corporate tax treatment. classification for tax purposes if transferability restrictions are inadequately maintained. These factors often influence fund structuring decisions despite the theoretical unlimited investor capacity.

Qualified purchasers represent the highest wealth threshold among federal investor protection categoriesFederal classifications such as accredited investor, qualified client, and qualified purchaser that determine regulatory protections and investment access.. They substantially exceed both accredited investor requirements ($1 million net worth or specified income levels) and qualified client standards ($2.2 million net worth or $1.1 million assets under management). This elevated threshold reflects the regulatory premise that investors with substantial investment assets possess sufficient sophistication and risk tolerance to evaluate complex investment strategies without comprehensive regulatory protections.

The distinction becomes particularly relevant for investment advisers managing multiple fund structures. Different investor categories enable access to different regulatory exemptions and fee arrangements. Understanding these relationships ensures appropriate fund structuring and investor allocation across various regulatory frameworks.