Rethinking the 'Qualified Client' Standard

The Securities and Exchange Commission (SEC) has proposed treating “accredited investors” under Regulation D as “qualified clients” under Rule 205-3 of the Investment Advisers Act of 1940, substantially expanding eligibility for performance fee arrangements. That expansion could become even broader if the SEC adopts additional credential- and examination-based pathways to accredited investor status.¹

Accredited Investors Would Become “Qualified Clients”

Under the SEC’s April 28, 2026, inflation-adjustment order, effective June 29, 2026, a client generally qualifies to be a “qualified client” if the client has at least $1.4 million under management with the adviser immediately after entering into the advisory contract, or if the adviser reasonably believes the client has a net worth of more than $2.7 million immediately before entering into the contract. The net-worth calculation excludes the client’s primary residence and applies special rules to related indebtedness.² Other qualification pathways and transition provisions also apply.

Under the current proposal, the amendments would change that framework by adding the Regulation D definition of “accredited investor” to the definition of qualified client. The proposal would remove both the existing net-worth test and the assets-under-management test, while retaining the qualified purchaser and knowledgeable employee pathways and generally grandfathering contractual relationships entered into before the amendments’ effective date.³

For individuals, the current accredited investor definition generally includes a person who:

• earned income exceeding $200,000 individually or $300,000 jointly with a spouse or spousal equivalent in each of the two preceding years, and reasonably expects to reach the same income level in the current year;
• has a net worth exceeding $1 million, individually or jointly with a spouse or spousal equivalent, excluding the value of the person’s primary residence; or
• holds certain professional certifications, designations or credentials recognized by the SEC, currently including the Series 7, Series 65 and Series 82 licenses in good standing. See Katten’s prior summary here.

The definition also covers specified entities, including (i) certain regulated financial institutions, (ii) entities that own more than $5 million in investments, (iii) certain entities with more than $5 million in total assets, and (iv) entities in which all equity owners are accredited investors.

The Accredited Investor Standard May Expand Further

The significance of the proposed Rule 205-3 amendments is amplified by the SEC's separate requests for comment on who may qualify as an “accredited investor.”

The SEC currently recognizes certain professional credentials as evidence that an individual possesses sufficient financial sophistication to assess an investment’s merits and risks. Separately, the SEC issued five requests seeking public comment on the potential designation, by SEC order, of six additional examination or credential-based pathways to accredited investor status under Rule 501(a)(10):

1. passage of an accredited investor examination to be developed by the Financial Industry Regulatory Authority (FINRA);
2. a US certified public accountant license in good standing;
3. a Chartered Financial Analyst charter in good standing;
4. a US Certified Financial Planner certification in good standing;
5. a FINRA Series 79 license; and
6. FINRA Series 86 and Series 87 licenses held together.⁴

As discussed in prior Katten articles, these pathways represent a shift from treating wealth as the principal basis for investor sophistication. The SEC has described the potential examination as a “non-financial pathway” through which investors could demonstrate sufficient sophistication in securities, investing, and financial and business matters to evaluate prospective investments.⁵

If the SEC adopts the Rule 205-3 amendments as proposed and issues orders recognizing additional accredited investor credentials or examinations, individuals qualifying through those new pathways would also qualify as qualified clients. The designations would add eligibility routes; they would not change the existing income or net-worth thresholds.

A Larger Pool of Investors Could Become Subject to Performance Fees

Section 205(a)(1) of the Advisers Act generally prohibits investment advisers registered or required to be registered with the SEC from entering into or performing advisory contracts providing for compensation based on a share of capital gains or capital appreciation, unless an exception or exemption applies. Rule 205-3 provides one such exemption for contracts with “qualified clients,” who are considered sufficiently financially sophisticated to enter into performance fee arrangements. Advisory contracts with Section 3(c)(7) funds already fall within a statutory exception under Section 205(b)(4), so the proposal would not create a new performance-fee gateway for those funds.

The practical consequence of this proposal is straightforward: it would not allow advisers to charge performance-based compensation to accredited investors who do not satisfy the current qualified client financial tests, while retaining the qualified purchaser and knowledgeable employee pathways. Separately, the proposal would permit advisers to regulated funds, including registered management investment companies and business development companies, to receive performance-based compensation, potentially encouraging private-market strategies to be offered through regulated products available to a broader investor base.

This expansion could broaden access to private equity, private credit, venture capital and hedge fund strategies, while at the same time exposing a larger number of investors to compensation arrangements that may incentivize greater risk-taking.⁶ The amendments would remove a performance-fee eligibility barrier for some investors; they would not, by themselves, eliminate other offering or fund eligibility requirements.  Advisers would remain subject to their fiduciary obligations, including those regarding material conflicts of interest and the calculation and administration of performance fees.

The proposal has not taken effect; comments are due December 7, 2026. Unless and until it becomes effective, advisers must continue applying Rule 205-3’s existing qualified client requirements.⁷

Final Thoughts

Although the proposed changes discussed above would generally broaden performance fee eligibility, it is not purely an expansion. Because the accredited investor standard would replace, rather than supplement, the existing qualified client dollar tests, some investors who qualify today could fall outside the amended definition for new advisory contracts. For example:

• an entity that currently qualifies under the $2.7 million net-worth test or the $1.4 million assets-under-management test, but does not meet the accredited investor definition’s $5 million investments or total-assets tests (or another accredited investor category), would no longer qualify; and
• an individual with at least $1.4 million under management with the adviser, but whose liabilities reduce his or her net worth below the accredited investor definition’s $1 million threshold, would no longer qualify unless he or she meets the income test or another accredited investor pathway.

The SEC expects these groups to be small in practice, but has requested comment on the issue. Existing contracts would generally be grandfathered, but new clients and investors, including new equity owners of an existing private fund, would be tested under the amended rule.⁸

Katten attorneys will continue to monitor developments as the SEC considers public comments and moves toward a final rule.