Glossary · Legal, regulatory & tax
Qualified Client
Also called: Rule 205-3 · qualified client test
A qualified client is a client from whom an adviser may take performance fees under Advisers Act Rule 205-3; since 29 June 2026, that chiefly means at least $1.4 million under the adviser's management or net worth above $2.7 million.
The Investment Advisers Act generally bars an adviser from being paid a share of its client's capital gains. Rule 205-3 lifts the bar for clients wealthy enough to negotiate such fees. In private funds, carried interest is a performance fee, so for a 3(c)(1) fund the test reaches through the fund to each investor.
Jurisdiction and status
Qualified client is a US federal term under the Investment Advisers Act of 1940. Section 205(a)(1) prohibits advisory contracts that pay the adviser on the basis of a share of capital gains or appreciation; Rule 205-3 (17 CFR 275.205-3) exempts contracts with qualified clients. The dollar amounts are not written into the rule: they are set by order of the Securities and Exchange Commission (SEC) and adjusted about every five years for inflation using the Personal Consumption Expenditures (PCE) Chain-Type Price Index, rounded to the nearest $100,000.
| Test | Current amount | Previous amount (2021 order) | Provision |
|---|---|---|---|
| Assets under management with the adviser, immediately after entering the contract | At least $1.4 million | $1.1 million | 205-3(d)(1)(i) |
| Net worth (including assets held jointly with a spouse), excluding the primary residence, immediately before entering the contract | More than $2.7 million | $2.2 million | 205-3(d)(1)(ii)(A) |
The current amounts were set by Order IA-6961, issued 28 April 2026 and effective 29 June 2026. Rule 205-3(e) provides for further orders approximately every five years after the order due on or about 1 May 2026, so the next adjustment is expected around 2031.
Section 205(a) applies to advisers "registered or required to be registered" with the SEC, and section 205(b)(4) takes contracts with funds relying on section 3(c)(7) outside the section 205(a)(1) prohibition.
Who qualifies
A client is a qualified client if, when the contract is entered into, it meets the AUM test or the net worth test above, or it is a qualified purchaser under Investment Company Act section 2(a)(51)(A). Certain insiders of the adviser also qualify: executive officers, directors, trustees and general partners of the adviser, and employees who participate in its investment activities and have done so for at least 12 months.
The adviser may rely on a reasonable belief that the net worth test is met.
Private funds: the look-through
For a "private investment company", defined in the rule as a company that would be an investment company but for section 3(c)(1), each equity owner is treated as a client. A registered adviser that takes carried interest or another performance fee from a 3(c)(1) fund therefore needs every investor that is charged the fee to be a qualified client; the adviser itself and equity owners not charged a performance fee are not treated as clients. The same look-through applies to registered investment companies and business development companies.
A 3(c)(7) fund is outside the look-through definition, and its investors are qualified purchasers, who are qualified clients by definition. This is one reason larger funds that charge carry are often structured under 3(c)(7).
Transition when the amounts change
The 2026 order is not retroactive. A contract that met the amounts in force when it was entered into continues to qualify. A person who becomes a party to a contract on or after 29 June 2026, including a new investor admitted to an existing 3(c)(1) fund, must meet the new amounts. Funds typically update subscription questionnaires on the effective date.
Legal definition and market usage
Qualified client is a fee-eligibility test, not an offering exemption. A 3(c)(1) fund still needs an exemption from Securities Act registration, usually under Regulation D (selling to accredited investors), and must stay within its beneficial-owner limit (100, or 250 for a qualifying venture capital fund). In market usage, a "qualified client fund" is a 3(c)(1) fund that charges carried interest and therefore limits itself to qualified clients.
Worked example
Illustrative effect of the 2026 change
On 1 August 2026 an individual with net worth of $2.5m (excluding the primary residence) subscribes $500,000 to a 3(c)(1) fund whose SEC-registered adviser charges 20% carried interest. Under the 2021 order the net worth test ($2.2m) would have been met. Under Order IA-6961, effective 29 June 2026, the net worth test requires more than $2.7m, and $2.5m is $0.2m below that level; the $500,000 subscription is also below the $1.4m AUM test, so neither test is met on these figures. The example illustrates the arithmetic of the thresholds, not a determination for any investor.
Examples are illustrative; figures are not market data.
Not the same as
- Accredited Investor: Accredited investor ($1 million net worth or $200,000 income) governs who may buy in a Regulation D offering; qualified client governs whether the adviser may charge that investor a performance fee.
- Qualified Purchaser (QP): Qualified purchaser is the higher investments-owned test that defines 3(c)(7) funds; every qualified purchaser is a qualified client.
Common mistakes
- Using the superseded $1.1 million / $2.2 million amounts for contracts entered into on or after 29 June 2026.
- Testing only the fund: for a 3(c)(1) fund each investor is a client for this rule.
- Assuming an accredited investor is a qualified client. The net worth test is $2.7 million, not $1 million.
- Including the primary residence in net worth.
- Treating qualified-client status as an offering exemption.
Edge cases
- Knowledgeable insiders of the adviser can invest in a carry-paying 3(c)(1) fund without meeting the dollar tests.
- Existing investors admitted before 29 June 2026 under the old amounts are grandfathered for that contract; the transition rules govern new parties.
Questions
What are the qualified client thresholds in 2026?
From 29 June 2026: at least $1.4 million under management with the adviser, or net worth above $2.7 million excluding the primary residence (Order IA-6961). Before that date the amounts were $1.1 million and $2.2 million.
When will the qualified client thresholds change again?
Rule 205-3(e) provides for adjustment orders approximately every five years. The current order, IA-6961, was issued on 28 April 2026, so the next is expected around 2031.
Sources
- 17 CFR 275.205-3 - Exemption from the compensation prohibition of section 205(a)(1) for investment advisers (qualified client). U.S. Securities and Exchange Commission (CFR text via eCFR; LII mirror), eCFR current as of 2026-09-29; last amended 86 FR 62475 (2021-11-10). Status: in force (checked 2026-10-01). 17 CFR 275.205-3(a), (b), (c)(1)-(3), (d)(1)-(3), (e) — supports: Exemption; look-through for private investment companies, RICs and BDCs; transition rules; qualified client tests, reasonable belief, QPs and insiders; PCE adjustment approximately every five years from the order due on or about 2026-05-01, rounded to $100,000
- Order Approving Adjustment for Inflation of the Dollar Amount Tests in Rule 205-3 under the Investment Advisers Act of 1940, Release No. IA-6961. U.S. Securities and Exchange Commission, Issued 2026-04-28; effective 2026-06-29. Status: in force (checked 2026-10-01). Release IA-6961 (issued 2026-04-28), Parts I-III — supports: Current $1,400,000 AUM and $2,700,000 net worth amounts; supersedes $1,100,000 / $2,200,000 (2021 order); effective 2026-06-29; not generally retroactive, subject to transition rules
- Private Equity Funds. U.S. Securities and Exchange Commission (Investor.gov), Accessed 2026-10-01. Status: current (checked 2026-10-01). Private Equity Funds — supports: Private funds are typically open only to accredited investors and qualified clients
- 15 U.S.C. 80b-5 - Investment advisory contracts (Advisers Act s.205). U.S. Congress (US Code via LII), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). Sec. 205(a), (a)(1), (b)(4) — supports: Scope of the performance-fee prohibition and 3(c)(7) exception
- 15 U.S.C. 80a-3 - Definition of investment company (Investment Company Act sec. 3, incl. 3(c)(1) and 3(c)(7)). U.S. Congress (United States Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). 15 U.S.C. 80a-3(c)(1), (c)(1)(C)(i) — supports: 100 beneficial owners, 250 for a qualifying venture capital fund