Inflation Adjustments to Qualified Client Thresholds for Performance Fees

Content

ACTION:

Notice of intent to issue order.

SUMMARY:

The Securities and Exchange Commission (the “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.

DATES:

Hearing requests should be received by the Commission's Office of the Secretary by 5:30 p.m. on April 27, 2026.

ADDRESSES:

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 Secretarys-Office@sec.gov. Hearing requests should state the nature of the writer's interest, the reason for the request, and the issues contested.

FOR FURTHER INFORMATION CONTACT:

Daniel Levine, Senior Counsel, at (202) 551-3937, Investment Adviser Regulation Office, Division of Investment Management,
Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-8549.

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) In 1970, Congress provided an exception from the prohibition for advisory contracts relating to the investment of assets in
excess of $1,000,000, (3) if an appropriate “fulcrum fee” is used. (4) 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. (5)

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. (6) 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. (7) In 1998, the Commission amended rule 205-3 to, among other things, change the dollar amounts of the assets-under-management
test and net worth test to adjust for the effects of inflation since 1985. (8) The Commission revised the former from $500,000 to $750,000, and the latter from $1,000,000 to $1,500,000. (9)

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) (10) 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. (11) 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). (12)

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. (13) 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. (14) Rule 205-3, as amended in 2012, stated that the Commission would 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, (15) and specified the price index on which future inflation adjustments would be based—the Personal Consumption Expenditures Chain-Type
Price Index (“PCE Index”), which is published by the United States Department of Commerce (16) and is used in other provisions of the Federal securities laws. (17)

On June 14, 2016 and June 17, 2021, the Commission issued orders adjusting for inflation, as appropriate, the dollar amount
thresholds of the assets-under-management test and the net worth test. (18) In November 2021, the Commission amended rule 205-3 to replace the specific dollar amount thresholds in the rule's net worth
and assets-under-management tests with references to the specific dollar amount thresholds adjusted for inflation in the most
recent order issued by the Commission. (19) The 2021 Amendments also updated the specific reference point in paragraph (e) of rule 205-3 from May 1, 2016 to “on or about
May 1, 2026, and approximately every five years thereafter” to establish the next expected date for issuance of a Commission
order.

As of August 16, 2021, the dollar amount of the assets-under-management test is $1,100,000, and the dollar amount of the net
worth test is $2,200,000. (20)

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.

II. Discussion

A. Order Adjusting Dollar Amount Tests

Pursuant to section 418 of the Dodd-Frank Act and rule 205-3(e), 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, 2026, and approximately every five years thereafter.
  We intend to issue an order that would increase the dollar amount of the assets-under-management test from $1,100,000 to $1,400,000
  and would increase the dollar amount of the net worth test from $2,200,000 to $2,700,000. 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 date. (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)

By the Commission.

Dated: March 27, 2026. Vanessa A. Countryman, Secretary. [FR Doc. 2026-06229 Filed 3-30-26; 8:45 am] BILLING CODE 8011-01-P

Footnotes

(1) 15 U.S.C. 80b. Unless otherwise noted, all references to statutory sections are to the Advisers Act, and all references to
rules under the Advisers Act, including rule 205-3, are to Title 17, Part 275 of the Code of Federal Regulations [17 CFR 275].

(2) 15 U.S.C. 80b-5(a)(1).

(3) 15 U.S.C. 80b-5(b)(2). Trusts, governmental plans, collective trust funds, and separate accounts referred to in section 3(c)(11)
of the Investment Company Act of 1940 (“Investment Company Act”) [15 U.S.C. 80a-3(c)(11)] are not eligible for this exception
from the performance fee prohibition under section 205(b)(2)(B) of the Advisers Act.

(4) 15 U.S.C. 80b-5(b). A fulcrum fee generally involves averaging the adviser's fee over a specified period and increasing or
decreasing the fee proportionately with the investment performance of the company or fund in relation to the investment record
of an appropriate index of securities prices. See rule 205-2 under the Advisers Act; Adoption of Rule 205-2 under the Investment Advisers Act of 1940, As Amended, Definition
of “Specified Period” Over Which Asset Value of Company or Fund Under Management is Averaged, Advisers Act Release No. 347
(Nov. 10, 1972) [37 FR 24895 (Nov. 23, 1972)]. In 1980, Congress added another exception to the prohibition against charging
performance fees, for contracts involving business development companies under certain conditions. See section 205(b)(3) of the Advisers Act.

(5) Section 205(e) of the Advisers Act. Section 205(e) of the Advisers Act authorizes the Commission to exempt conditionally
or unconditionally from the performance fee prohibition advisory contracts with persons that the Commission determines do
not need its protections. Section 205(e) provides that the Commission may determine that persons do not need the protections
of section 205(a)(1) 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 such other factors as the Commission determines are consistent with [section 205].”

(6) Exemption To Allow Registered Investment Advisers To Charge Fees Based Upon a Share of Capital Gains Upon or Capital Appreciation
of a Client's Account, Advisers Act Release No. 996 (Nov. 14, 1985) 50 FR 48556 (Nov. 26, 1985).
The exemption applies to the entrance into, performance, renewal, and extension of advisory contracts. See rule 205-3(a).

(7) See 1985 Adopting Release, supra footnote 6, at Sections I.C and II.B. The rule also imposed other conditions, including specific disclosure requirements and
restrictions on calculation of performance fees. See id. at Sections II.C-E.

(8) See Exemption To Allow Investment Advisers To Charge Fees Based Upon a Share of Capital Gains Upon or Capital Appreciation of
a Client's Account, Advisers Act Release No. 1731 (July 15, 1998) [63 FR 39022 (July 21, 1998)].

(9) See id. at Section II.B.1.

(10) Public Law 111-203, 124 Stat. 1376 (2010).

(11) See section 418 of the Dodd-Frank Act (requiring the Commission to issue an order every five years revising dollar amount tests
in a rule that exempts a person or transaction from section 205(a)(1) of the Advisers Act if the dollar amount test was a
factor in the Commission's determination that the persons do not need the protections of that section).

(12) See Investment Adviser Performance Compensation, Advisers Act Release No. 3198 (May 10, 2011) [76 FR 27959 (May 13, 2011)]. The
Commission issued an order to revise the dollar amount thresholds of the assets-under-management and net worth tests, as described
above, on July 12, 2011. See Order Approving Adjustment for Inflation of the Dollar Amount Tests in Rule 205-3 under the Investment Advisers Act of 1940,
Advisers Act Release No. 3236 (July 12, 2011) 76 FR 41838 (July 15, 2011). The 2011 Order was effective as
of September 19, 2011. Id. The 2011 Order applied to contractual relationships entered into on or after the effective date and did not apply retroactively
to contractual relationships previously in existence.

(13) See May 2011 Release, supra footnote 12.

(14) See Investment Adviser Performance Compensation, Advisers Act Release No. 3372 (Feb. 15, 2012) 77 FR 10358 (Feb. 22, 2012); see also rule 205-3(d)(1)(i) through (ii).

(15) See rule 205-3(e).

(16) See rule 205-3(e)(1). The PCE Index is an indicator of inflation in the personal sector of the U.S. economy. See Performance-Based Investment Advisory Fees, Advisers Act Release No. 4388 (May 18, 2016) [81 FR 32686 (May 24, 2016)], at
text accompanying n.20.

(17) See e.g., Qualifying Venture Capital Funds Inflation Adjustment, Investment Company Act Release No. 35305 (Aug. 21, 2024) 89 FR 70479
(Aug. 30, 2024); Definitions of Terms and Exemptions Relating to the “Broker” Exceptions for Banks, Securities
Exchange Act Release No. 56501 (Sept. 24, 2007) 72 FR 56514 (Oct. 3, 2007);
Amendments to Form ADV, Advisers Act Release No. 3060 (July 28, 2010) 75 FR 49234 (Aug. 12, 2010). The Dodd-Frank Act also requires the use of the PCE Index to calculate inflation adjustments for the cash limit protection
of each investor under the Securities Investor Protection Act of 1970. See section 929H(a) of the Dodd-Frank Act; see also Securities Investor Protection Corporation, Securities Investor Protection Act of 1970 Release No. 183 (Jan. 27, 2021) [86
FR 7900 (Feb. 2, 2021)].

(18) Order Approving Adjustment for Inflation of the Dollar Amount Tests in Rule 205-3 under the Investment Advisers Act of 1940,
Advisers Act Release No. 4421 (June 14, 2016) 81 FR 39985 (June 20, 2016). The 2016 Order was effective as
of August 15, 2016. Order Approving Adjustment for Inflation of the Dollar Amount Tests in Rule 205-3 under the Investment
Advisers Act of 1940, Advisers Act Release No. 5756 (June 17, 2021) 86 FR 32993 (June 23, 2021). The 2021
Order was effective as of August 16, 2021.

(19) See Performance-Based Investment Advisory Fees, Advisers Act Release No. 5904 (Nov. 4, 2021) 86 FR 62473 (Nov. 10, 2021). The 2021 Amendments define “most recent order” as the most recently issued Commission order in accordance with
paragraph (e) of rule 205-3 and as published in the
Federal Register
.

(20) See 2021 Order.

(21) See section 211(c) of the Advisers Act (requiring the Commission to provide appropriate notice of and opportunity for hearing
for orders issued under the Advisers Act).

(22) Specifically, rule 205-3(e) provides that the adjusted dollar amounts shall be computed by: (1) dividing the year-end value
of the PCE Index (or any successor index thereto) for the calendar year preceding the calendar year in which the order is
being issued (in this case, 2025), by the year-end value of the PCE Index (or successor) for the calendar year 1997 (such
quotient, the “Adjustment Percentage”); (2) for the assets-under-management test, multiplying $750,000 by the Adjustment Percentage
and rounding the product to the nearest multiple of $100,000; and (3) for the net worth test, multiplying $1,500,000 by the
Adjustment Percentage and rounding the product to the nearest multiple of $100,000. As of March 26, 2026, the end-of-year
2025 PCE Index was 128.214, and the end-of-year 1997 PCE Index was 70.710. Assets-under-management test calculation to adjust
for the effects of inflation: (128.214/70.710) × $750,000 = $1,359,927.87; $1,359,927.87 rounded to the nearest multiple
of $100,000 = $1,400,000. Net worth test calculation to adjust for the effects of inflation: (128.214/70.710) × $1,500,000
= $2,719,855.75; $2,719,855.75 rounded to the nearest multiple of $100,000 = $2,700,000. The values of the PCE Index are available
from the Bureau of Economic Analysis, a bureau of the United States Department of Commerce. See http://www.bea.gov; see also Bureau of Economic Analysis, Table 2.3.4., “Price Indexes for Personal Consumption Expenditures by Major Type of Product,” available at https://apps.bea.gov/iTable/?reqid=19&step=3&isuri=1&select_all_years=0&nipa_table_list=64&series=a&first_year=1997&last_year=2020&scale=-99&categories=survey&thetable#eyJhcHBpZCI6MTksInN0ZXBzIjpbMSwyLDMsM10sImRhdGEiOltbInNlbGVjdF9hbGxfeWVhcnMiLCIwIl0sWyJuaXBhX3RhYmxlX2xpc3QiLCI2NCJdLFsic2VyaWVzIiwiUSJdLFsiZmlyc3RfeWVhciIsIjE5OTUiXSxbImxhc3RfeWVhciIsIjIwMjUiXSxbInNjYWxlIiwiMCJdLFsiY2F0ZWdvcmllcyIsIlN1cnZleSJdLFsidGhldGFibGUiLCIiXV19= (last visited March 26, 2026).

(23) When the Commission issued the 2011, 2016, and 2021 Orders adjusting the dollar amount tests of rule 205-3 as described above,
the effective dates of the Orders were approximately 60 days following their issuance. See 2011 Order, supra footnote 12, at section III; 2016 Order, supra footnote 18, at section III; 2021 Order, supra footnote 18, at section III.

(24) See rule 205-3(c)(1) (“If a registered investment adviser entered into a contract and satisfied the conditions of this section
that were in effect when the contract was entered into, the adviser will be considered to satisfy the conditions of this section;
Provided, however, that if a natural person or company who was not a party to the contract becomes a party (including an equity
owner of a private investment company advised by the adviser), the conditions of this section in effect at that time will
apply with regard to that person or company.”); see also May 2011 Release, supra footnote 12, at section II.B.3.

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