SEC Rule 205-3 Raises AUM to $1.4M, Net Worth to $2.7M

April 10, 2026

SEC Announces 2026 Inflation Adjustment to Qualified Client Thresholds

Alston & Bird + Follow Contact LinkedIn Facebook X Send Embed The Securities and Exchange Commission has proposed increasing the “qualified client” thresholds under Rule 205-3, raising the assets-under-management (AUM) and net worth tests. Our Investment Funds Group outlines the likely implications for performance fee eligibility, investor qualifications, and fund operations.

• Thresholds would rise to $1.4 million AUM and $2.7 million net worth if the proposal becomes effective, as is expected
• Anticipated mid-2026 compliance timeline following a May 2026 order
• Grandfathering would be limited to existing contracts, with new parties tested at entry On March 27, 2026, the Securities and Exchange Commission (SEC) issued a notice of its intent to adjust the “qualified client” dollar thresholds under Advisers Act Rule 205-3 for inflation (Release No. IA-6955). The proposed adjustments would increase the assets-under-management (AUM) test threshold from $1.1 million to $1.4 million and the net worth test threshold from $2.2 million to $2.7 million.

The formal order is expected to be issued on or about May 1, 2026, with an effective date approximately 60 days later, implying a mid-2026 compliance deadline. Existing contracts are grandfathered; however, new parties—including new investors in 3(c)(1) funds—must satisfy the thresholds in effect at the time they become parties.

Background

By default, Section 205(a)(1) of the Investment Advisers Act of 1940, as amended, prohibits an investment adviser registered with the SEC from entering into, extending, or renewing 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 the client (e.g., carried interest or performance fees). An exception applies for investors who meet a qualified client test, reflecting the assumption that investors who meet this financial threshold have sufficient resources and sophistication to understand and bear the risks that come with performance-based compensation.

For any fund that relies on Section 3(c)(1) of the Investment Company Act of 1940, as amended, for an exemption from being an investment company, the adviser must look through to the fund’s investors to confirm that each investor meets the qualified client requirements. This look-through requirement does not apply to private funds relying on the exception under Section 3(c)(7), which are treated as the “client” for purposes of Rule 205-3.

Historical Evolution of the Qualified Client Thresholds

The qualified client thresholds have been periodically adjusted since Rule 205-3 was adopted, including in 2011, 2016, and 2021, pursuant to Section 418 of the Dodd–Frank Act and Rule 205-3, which require the SEC to adjust these dollar amounts for inflation every five years, rounded to the nearest $100,000.

Under the current rule, a client qualifies under one of the following pathways:

• Assets-Under-Management Test. At least $1.1 million in AUM with the adviser immediately after entering into the contract.
• Net Worth Test. Net worth exceeding $2.2 million (excluding primary residence and related debt).
• Qualified Purchase. Persons who are “qualified purchasers”, as well as “knowledgeable employees” also satisfy the qualified client definition.

What Is Changing

The SEC’s March 27, 2026 notice of intent reflects a mechanical, inflation-driven reset of the qualified client thresholds under Rule 205-3.

Qualified Client Thresholds: Current vs. Proposed

These adjustments are intended to preserve the rule’s restrictive nature over time.

Timing and Effective Date

The notice is a precursor to a formal order expected on or about May 1, 2026. Consistent with prior SEC practice, the updates would become effective approximately 60 days after issuance, making them operative in mid-2026 for new contracts and new parties.

Grandfathering and Transition Mechanics

Contractual relationships entered into prior to the effective date will be grandfathered under the prior thresholds. This protection, however, has important limits. If an investor enters into a subscription agreement, or certain investors enter into an investment management agreement, on or after the effective date with a 3(c)(1) private fund, business development company, or registered investment company, the updated thresholds will apply.

Practical Implications for Investment Professionals

• Performance Fee Eligibility Tightens. Higher thresholds reduce the pool of investors who qualify solely on AUM or net worth grounds, increasing reliance on alternative qualified client pathways such as qualified purchaser or knowledgeable employee status.
• Operational Impact Greatest for 3(c)(1) Funds. Because each investor is individually tested, new subscriptions and certain transfers must be underwritten against the updated thresholds once effective.
• Subscription and Transfer Diligence Must Be Date-Sensitive. Grandfathering protects existing contracts, but new parties must meet the thresholds in effect at entry. Clear documentation of timing and investor of status is critical.
• Offering Documents and Subscription Materials Should Be Updated. Advisers should update offering documents and subscription or transfer materials for any closings or transfers expected to occur on or after the effective date.
• Adviser Type Matters. The performance fee restriction applies to advisers “registered or required to be registered” with the SEC; exempt reporting advisers, foreign private advisers, and family offices are outside the restriction’s direct scope, though managers should assess their specific regulatory status and any state-level performance fee restrictions. [View source.]

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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