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AGENCY:
Securities and Exchange Commission.
ACTION:
Intent to issue order.
SUMMARY:
The Securities and Exchange Commission (“Commission”) intends to issue an order that would adjust for inflation dollar amount thresholds in the rule under the Investment Advisers Act of 1940 that permits investment advisers to charge performance-based fees to “qualified clients.” Under that rule, an investment adviser may charge performance-based fees if a “qualified client” has a certain minimum net worth or minimum dollar amount of assets under the management of the adviser. The Commission's order would increase, to reflect inflation, the minimum net worth that a “qualified client” must have under the rule. The order would also increase, to reflect inflation, the minimum dollar amount of assets under management.
Hearing or Notification of Hearing: An order adjusting the dollar amount tests specified in the definition of “qualified client” will be issued unless the Commission orders a hearing. Interested persons may request a hearing by writing to the Commission's Secretary. Hearing requests should be received by the Commission's Office of the Secretary by 5:30 p.m. on June 4, 2021. Hearing requests should state the nature of the writer's interest, the reason for the request, and the issues contested. Persons who wish to be notified of a hearing may request notification by writing to the Commission's Secretary. Any such communication should be emailed to the Commission's Secretary at .
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FOR FURTHER INFORMATION CONTACT:
Matthew Cook, Senior Counsel, at (202) 551-6787 or , Investment Adviser Regulation Office, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-8549.
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SUPPLEMENTARY INFORMATION:
The Commission intends to issue an order under the Investment Advisers Act of 1940 (“Advisers Act” or “Act”).[1]
I. Background
Section 205(a)(1) of the Advisers Act generally prohibits an investment adviser from entering into, extending, renewing, or performing any investment advisory contract that provides for compensation to the adviser based on a share of capital gains on, or capital appreciation of, the funds of a client.[2] Congress prohibited these compensation arrangements (also known as performance compensation or performance fees) in 1940 to protect advisory clients from arrangements that Congress believed might encourage advisers to take undue risks with client funds to increase advisory fees.[3] In 1970, Congress provided an exception from the prohibition for advisory contracts relating to the investment of assets in excess of $1,000,000,[4] if an appropriate “fulcrum fee” is used.[5] Congress subsequently authorized the Commission to exempt, by rule or order, any advisory contract from the performance fee prohibition if the contract is with any person that the Commission determines does not need the protections of that prohibition.[6]
The Commission adopted rule 205-3 in 1985 to exempt an investment adviser from the prohibition against charging a client performance fees in certain circumstances.[7] The rule, when adopted, allowed an adviser to charge performance fees if the client had at least $500,000 under management with the adviser immediately after entering into the advisory contract (“assets-under-management test”) or if the adviser reasonably believed, immediately prior to entering into the advisory contract, that the client had a net worth of more than $1,000,000 at the time the contract was entered into (“net worth test”). The Commission stated that these standards would limit the availability of the exemption to clients who are financially experienced and able to bear the risks of performance fee arrangements.[8] In 1998, the Commission amended rule 205-3 to, among other Start Printed Page 26686things, change the dollar amounts of the assets-under-management test and net worth test to adjust for the effects of inflation since 1985.[9] The Commission revised the former from $500,000 to $750,000, and the latter from $1,000,000 to $1,500,000.[10]
The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) [11] amended section 205(e) of the Advisers Act to provide that, by July 21, 2011 and every five years thereafter, the Commission shall, by order, adjust for the effects of inflation the dollar amount thresholds included in rules issued under section 205(e), rounded to the nearest multiple of $100,000.[12] In May 2011, the Commission published a release (the “May 2011 Release”) that included a notice of intent to issue an order revising the dollar amount thresholds of the assets-under-management test (from $750,000 to $1,000,000) and the net worth test (from $1,500,000 to $2,000,000).[13]
The May 2011 Release also proposed amendments to rule 205-3 providing, among other things, that the Commission would issue an order every five years in the future adjusting the rule's dollar amount thresholds for inflation.[14] On February 15, 2012, the Commission adopted these proposed amendments, which amended rule 205-3 to carry out the inflation adjustment of the rule's dollar amount thresholds.[15] Rule 205-3, as amended, states that the Commission will issue an order on or about May 1, 2016, and approximately every five years thereafter, adjusting for inflation the dollar amount thresholds of the rule's assets-under-management and net worth tests,[16] and specifies the price index on which future inflation adjustments will be based—the Personal Consumption Expenditures Chain-Type Price Index (“PCE Index”), which is published by the United States Department of Commerce,[17] and is used in other provisions of the federal securities laws.[18]
On June 14, 2016, the Commission issued an order adjusting for inflation, as appropriate, the dollar amount thresholds of the assets-under-management test and the net worth test.[19] As of August 15, 2016, the dollar amount of the assets-under-management test is $1,000,000, and the dollar amount of the net worth test is $2,100,000.[20]
II. Discussion
A. Order Adjusting Dollar Amount Tests
Pursuant to section 418 of the Dodd-Frank Act and rule 205-3(e), today we are providing notice [21] that the Commission intends to issue an order making the required inflation adjustment to the assets-under-management test and the net worth test in the definition of “qualified client” in rule 205-3. As discussed above, rule 205-3(e) requires that we adjust the dollar amount thresholds of the rule by order on or about May 1, 2016 and every five years thereafter. We intend to issue an order that would increase the dollar amount of the assets-under-management test from $1,000,000 to $1,100,000, and would increase the dollar amount of the net worth test from $2,100,000 to $2,200,000. As required under rule 205-3, both dollar amounts would take into account the effects of inflation by reference to historic and current levels of the PCE Index. Because the amount of the Commission's inflation adjustment calculations are larger than the rounding amount specified under rule 205-3, the dollar amounts of both tests would be adjusted as a result of the Commission's inflation adjustment calculation effected pursuant to the rule.[22]
B. Effective Date
We anticipate that, if we issue the order described above, the effective date will be 60 days following the order Start Printed Page 26687date.[23] To the extent that contractual relationships are entered into prior to the order's effective date, the dollar amount test adjustments in the order would not generally apply retroactively to such contractual relationships, subject to the transition rules incorporated in rule 205-3.[24]
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By the Commission.
Dated: May 10, 2021.
J. Matthew DeLesDernier,
Assistant Secretary.
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