The Securities and Exchange Commission is proposing to raise the dollar thresholds for someone to be considered a “qualified client.”
The definition of a qualified client is set out in Rule 205-3. This is an exemption to the Section 205(a)(1) general prohibition on performance fees. Section 205(e) grants the SEC the power to create an exemption from the limitation “on the basis of such factors as financial sophistication, net worth, knowledge of and experience in financial matters, amount of assets under management, relationship with a registered investment adviser,” and other factors. The SEC created an exemption in Rule 205-3 for “qualified clients.”
Section 418 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires the SEC to adjust the standard for a Qualified Client for the effects of inflation within one year and then every five years.
Back in August I predicted the standard would be raised to a minimum investment of $1 million and the minimum net worth would rise to $2 million. I was proven wrong about my prediction of a rise in the accredited investor standard.
The SEC is proposing that the standard increase to a minimum investment of $1 million and the minimum net worth would rise to $2 million. As to net worth, they are excluding the value of a person’s primary residence.
The SEC is using the same primary residence calculation they used in the “new” accredited investor standard. So, if you owe more on your mortgage than the value of your house, then you need to treat the overage as a negative asset. Once again, owning a house can only be a negative for the SEC standards.
While I used the CPI-I standard as the benchmark for inflation, the SEC chose to use the Personal Consumption Expenditures Chain-Type Price Index (“PCE Index”), published by the Department of Commerce
One of the comments the SEC is seeking in the proposed rule is whether the PCE index is the appropriate measure of inflation.
As for private funds, Rule 205-3(b) requires a look -through from the fund to the investors in the fund. Each “equity owner … will be considered a client for purposes of the” limitation. If the fund is relying on the 3(c)(7) exemption from the Investment Company Act then the fund’s investors should be “qualified purchasers” and you won’t need to look much further. If the fund is using the 3(c)(1) exemption, then it will need to take a closer look at its investors to make sure that each is a qualified client.
- SEC Release IA 3198 (.pdf) notice of intent to issue order on qualified client standard
- SEC Publishes Notice Regarding Inflation Indexing of Performance Fee Rule – SEC press release
- Changes to the Qualified Client Standard – prior post on Compliance Building
- Performance Fees for Private Investments Funds under the Investment Adviser Act – prior post on Compliance Building
- Comparing the Consumer Price Index and the Personal Consumption Expenditures Price Index (.pdf) by Clinton P. McCully, Brian C. Moyer, and Kenneth J. Stewart
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