Key Points

• SEC qualified client thresholds increase on June 29, 2026, raising the Rule 205-3 assets-under-management test to $1.4 million and the net worth test to $2.7 million for investment advisers that charge performance fees, carried interest or incentive allocations.
• Private fund managers and SEC-registered investment advisers should update subscription documents, investor questionnaires, compliance policies and onboarding systems now.
• The new thresholds may create added compliance risk for 3(c)(1) funds, fund-of-funds structures and advisers relying on state law exemptions.

The Securities and Exchange Commission (the SEC) recently issued Release No. IA-6961, adjusting for inflation the dollar amount thresholds that determine who qualifies as a "qualified client" under Rule 205-3 (Rule 205-3) of the Investment Advisers Act of 1940 (the Advisers Act). These revised thresholds become effective on June 29, 2026, and will directly affect the ability of SEC-registered investment advisers to charge performance-based compensation, including the carried interest and incentive allocations that are a defining feature of private fund economics.

This alert summarizes the new thresholds, explains who is affected and how, identifies critical transition and grandfathering mechanics, and provides a practical roadmap for fund managers, compliance professionals and legal counsel to implement the required changes.

Any SEC-registered investment adviser that anticipates admitting new investors, accepting additional capital commitments or otherwise entering into new advisory arrangements on or after June 29, 2026, must apply the updated qualified client thresholds to those arrangements. While existing contracts and investments are grandfathered under prior thresholds, new subscriptions and additional investments made after the effective date are not. Advisers should begin updating their subscription documents, compliance policies and operational workflows immediately.

Background on Rule 205-3 and the Performance Fee Prohibition

Section 205(a)(1) of the Advisers Act generally prohibits SEC-registered investment advisers from receiving compensation based on a share of capital gains upon, or capital appreciation of, the funds of a client. This prohibition was originally enacted to address concerns that performance-based compensation could incentivize excessive risk-taking by investment advisers. Rule 205-3 provides an important exception: advisers may charge performance-based fees to clients who meet the definition of a "qualified client," on the theory that such persons possess sufficient financial sophistication and resources to bear the risks associated with performance-based fee arrangements.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 added Section 418 to the Advisers Act, requiring the SEC to adjust the qualified client thresholds for inflation every five years. The SEC must use the Personal Consumption Expenditures Chain-Type Price Index published by the Department of Commerce and must round to the nearest $100,000. The Commission last completed this adjustment in June 2021, and the current order represents the most recent inflation-mandated update.

The practical importance of the qualified client standard to the private equity and hedge fund industry cannot be overstated. Unlike the more commonly discussed "accredited investor" standard under Regulation D, which governs who may purchase securities in a private offering, the qualified client standard governs whether a registered investment adviser may receive performance-based compensation from an investor. For private fund managers that have structured their investment funds as exempt pursuant to Section 3(c)(1) under the Investment Company Act of 1940 (3(c)(1) funds), this distinction is critical: even if an investor qualifies as an accredited investor and is legally permitted to invest in the fund, the adviser cannot collect performance fees or carried interest from that investor unless the investor independently satisfies the qualified client test.

The New Thresholds

Effective June 29, 2026, the qualified client thresholds increase as follows. The assets-under-management test increases from $1,100,000 to $1,400,000. This test looks to the value of assets under management with the adviser immediately after entering into the advisory contract and includes both uncalled capital commitments and the gross asset value or fair value of existing investments managed by the adviser on behalf of that client. The net worth test increases from $2,200,000 to $2,700,000. Consistent with prior practice, net worth is calculated to include assets held jointly with a spouse but excludes the value of the investor's primary residence and any indebtedness secured by that residence.

For historical context, these thresholds have increased steadily since the SEC first established them. In 1998, the assets-under-management test was $750,000 and the net worth test was $1,500,000. In 2012, those figures rose to $1,000,000 and $2,000,000 respectively. No adjustment was required in the 2016 review cycle because cumulative inflation had not reached the rounding threshold. The 2021 adjustment brought the figures to $1,100,000 and $2,200,000. The current increase to $1,400,000 and $2,700,000 reflects the cumulative effect of the inflationary environment of recent years.

Who Is Affected: The Four Pathways to Qualified Client Status

Rule 205-3 provides four independent pathways by which an investor may satisfy the qualified client standard. First, the assets-under-management test, now set at $1,400,000, measures the value of assets the investor places under the adviser's management. Second, the net worth test, now set at $2,700,000, measures the investor's overall financial position exclusive of the primary residence. Third, an investor who is a "qualified purchaser" as defined in Section 2(a)(51)(A) of the Investment Company Act of 1940 is automatically deemed a qualified client. The qualified purchaser threshold, which requires $5 million in investments for natural persons or $25 million for institutional investors, is not affected by this order and remains unchanged. Fourth, a "knowledgeable employee" of the adviser qualifies regardless of personal net worth. Knowledgeable employees include executive officers, directors, trustees and general partners of the adviser or its affiliates, as well as employees who have regularly participated in the investment activities of the adviser for at least 12 months. Additionally, non-U.S. residents are not subject to the performance fee restriction at all under Section 205(b)(5) of the Advisers Act.

The threshold increase narrows the pool of investors who qualify solely on the basis of the assets-under-management or net worth tests. As a practical matter, this will increase reliance on the qualified purchaser and knowledgeable employee pathways, particularly for funds with investors who fall in the zone between the old and new thresholds. Some fund managers may wish to evaluate whether restructuring their investment funds to rely on the exemption found in Section 3(c)(7) of the Investment Company Act (a 3(c)(7) fund), which by definition admits only qualified purchasers, would simplify compliance in light of the higher thresholds.

Grandfathering and Transition Mechanics

Rule 205-3(c)(1) provides grandfathering relief for existing advisory contracts and fund investments entered before the effective date of a threshold adjustment. Specifically, advisory contracts entered before June 29, 2026, remain valid under the prior thresholds and existing investors in a 3(c)(1) fund who subscribed before that date need not be re-qualified under the new standard. This means that an investor who met the $1,100,000 assets-under-management test or the $2,200,000 net worth test at the time of their original subscription remains a qualified client for purposes of that existing arrangement.

However, the grandfathering provision is narrower than it may first appear, and advisers should not treat it as a basis for inaction. If a new investor becomes a party to an existing advisory arrangement on or after June 29, 2026, the new thresholds apply to that investor. This includes any new investor subscribing to a 3(c)(1) fund after the effective date, regardless of when the fund was originally launched. Similarly, if an existing investor increases their interest in a fund or otherwise makes an additional investment after the effective date, the adviser must apply the updated thresholds to that investor with respect to the new or additional investment. For performance fee-paying registered funds that issue shares monthly, the new thresholds apply beginning with July 1, 2026, subscriptions.

The grandfathering rules thus create a bifurcated regime during any open fundraising period that straddles the June 29, 2026, effective date. Investors admitted before that date remain qualified under the old thresholds. Investors admitted on or after that date must meet the new thresholds. This necessitates careful documentation and operational controls to ensure that the correct standard is applied to each investor based on the timing of their commitment.

The Indirect Look-Through Requirement and the Fund-of-Funds Trap

For the 3(c)(1) funds, Rule 205-3 imposes a look-through requirement. The adviser must look through the fund vehicle to each individual investor and confirm that each investor independently satisfies the qualified client test. This look-through applies on an investor-by-investor basis and any investor that does not meet the standard cannot be charged performance-based fees.

This requirement does not apply to 3(c)(7) funds, whose investors by definition must be qualified purchasers, and qualified purchasers are automatically deemed qualified clients. This structural difference is one reason that the 3(c)(7) exemption continues to be attractive for managers that wish to charge performance-based fees without the administrative burden of individualized, qualified client verification.

A particularly important and often overlooked aspect of the look-through requirement is that it applies on an indirect basis as well. If a 3(c)(1) fund accepts subscriptions from funds of funds, including secondary funds, and those feeder vehicles are not held entirely by qualified purchasers, the underlying investee fund must discount its performance-based fees by the amount necessary to exclude indirect investors that are not qualified clients. This indirect look-through obligation creates significant compliance complexity for fund managers that accept capital from intermediary vehicles.

Many subscription agreements currently in the market do not include adequate representations or screening mechanisms to identify the indirect participation of persons who are not qualified clients through 3(c)(1) feeder funds that independently qualify as qualified purchasers based on their own asset levels. This is a gap in current market practice that should be affirmatively addressed in connection with the threshold update. Advisers should consider adding specific representations regarding the composition of any investing vehicle's underlying investor base and should assess whether existing side letter provisions or most-favored-nation rights create any exposure in this regard.

State Law Implications

An often-overlooked consequence of the federal threshold adjustment is its ripple effect at the state level. Many states incorporate by reference the qualified client standard under Rule 205-3 when applying state-level investment adviser registration exemptions and other regulatory requirements. As a result, the threshold increase affects not only SEC-registered advisers but also certain advisers that are not registered with the SEC and instead rely on state-level private fund adviser registration exemptions that require fund interests to be offered exclusively to qualified clients.

The performance fee restriction under Section 205(a)(1) of the Advisers Act applies by its terms only to advisers "registered or required to be registered" with the SEC. Exempt reporting advisers, foreign private advisers and family offices therefore fall outside the restriction's direct scope. However, these categories of advisers should nonetheless assess whether the threshold change affects their specific regulatory status under state law, whether their organizational documents or advisory contracts reference the qualified client standard by incorporating the dollar thresholds rather than a dynamic reference to the rule and whether any state-level performance fee restrictions independently apply to their activities.

Practical Steps for Fund Managers and Advisers

The compressed timeline between today and the June 29, 2026, effective date calls for action across multiple operational and legal workstreams. Advisers should begin by updating all subscription booklets and investor questionnaires to reflect the new $1,400,000 assets-under-management threshold and the new $2,700,000 net worth threshold. Private placement memoranda should be revised to disclose the new thresholds, and advisers should confirm that all references to the qualified client standard throughout the document are consistent and accurate. Compliance manuals and policies and procedures should be updated to reflect the new dollar figures and to provide clear guidance to compliance personnel on the application of the grandfathering provision to existing versus new investors. Marketing materials that reference performance-based fee eligibility requirements should be reviewed and revised.

As a forward-looking measure, advisers may wish to consider replacing hard-coded dollar references in their subscription documents and compliance materials with a dynamic reference to the "most recent Commission order" adjusting the qualified client thresholds. This approach future-proofs materials against subsequent five-year adjustments and reduces the operational burden of updating documents each time the SEC issues a new inflation-adjustment order.

Finally, advisers should consider adding explanatory disclosures that clearly distinguish the qualified client standard from other regulatory status tests that investors encounter in the subscription process. Many investors conflate accredited investor status, qualified purchaser status and qualified client status, and clear disclosure reduces the risk of investor confusion and misrepresentation in subscription documents.

Fund administrators should also ensure they are applying the correct thresholds to subscriptions received on or after the effective date. Digital subscription platforms used for electronic investor onboarding should be updated to reflect the new thresholds in their qualification logic. Transfer agreements for limited partnership interests should also be revised, because any transfer of a fund interest that occurs after the effective date constitutes a new investment by the transferee and the transferee must satisfy the updated qualified client standard.

Connection to the SEC 2026 Examination Priorities

Under Chairman Paul Atkins, the Division of Examinations published its 2026 Examination Priorities on November 17, 2025. These priorities do not specifically reference the qualified client threshold adjustment. However, several stated priority areas are directly relevant to an adviser's obligations in connection with this change, and advisers should expect that compliance with the updated thresholds will be evaluated as part of broader examination activity.

The 2026 priorities emphasize the effectiveness of advisers' compliance programs, including whether policies and procedures adequately address fee-related conflicts of interest. An adviser whose subscription documents continue to reference the prior $1,100,000 and $2,200,000 thresholds after June 29, 2026, has a compliance program deficiency that an examiner would likely identify and cite. The priorities also specifically focus on advisers to newly launched private funds and advisers that have not previously advised private funds, examining such advisers for regulatory awareness, liquidity management, valuation practices, fee calculations and disclosures. Additionally, the Division has stated its intent to assess whether policies and procedures are actually implemented and enforced, and whether disclosures address fee-related conflicts with a focus on conflicts that arise from account and product compensation structures.

The priorities further identify private credit and alternative investments as areas of enhanced focus and prioritize examinations of never-examined advisers and recently registered advisers. While Chairman Atkins has stated that examinations "should not be a gotcha exercise" and should "enable firms to prepare to have a constructive dialogue with SEC examiners," this posture does not diminish the practical importance of maintaining current and accurate qualified client documentation.

Historically, the SEC has conducted targeted sweeps and issued risk alerts in connection with regulatory threshold changes and new rule implementations. The Marketing Rule Risk Alert issued in December 2025 is a recent example of this pattern. While no comparable risk alert has been issued in connection with the current threshold adjustment, the practical takeaway for advisers is clear: stale qualified client representations in subscription documents would be identified as a deficiency by any examiner reviewing an adviser's compliance program and performance fee eligibility is a core area of compliance review.

Looking Ahead

The qualified client threshold adjustment is a mechanical, inflation-driven regulatory change, but its practical implications for private fund managers are significant and time-sensitive. The narrowing of the investor pool that qualifies under the assets-under-management and net worth tests will require careful attention to investor qualification, subscription documentation, compliance infrastructure and operational workflows. The grandfathering provision offers comfort for existing arrangements, but provides no relief for new subscriptions and additional investments made after June 29, 2026. Advisers that do not update their materials and processes risk both regulatory exposure and the practical inability to charge performance-based compensation to investors who would otherwise be eligible.

For more information, please contact Matt Bobrow at 212.878.7927 or mbobrow@foxrothschild.com, Arina Shulga at 212.450.9846 or ashulga@foxrothschild.com, or another member of Fox Rothschild’s Investment Fund Formation & Management Practice.

This information is intended to inform firm clients and friends about legal developments, including the decisions of courts and administrative bodies. Nothing in this alert should be construed as legal advice or a legal opinion. Readers should not act upon the information contained in this alert without seeking the advice of legal counsel. Views expressed are those of the authors and not necessarily this law firm or its clients.