In November 2013, the Division of Investment Management of the Securities and Exchange Commission (the “SEC”) issued an IM Guidance Update regarding the status of certain investors in private funds (including hedge funds and private equity funds) as “qualified clients” as defined in Rule 205-3 under the Investment Advisers Act of 1940 (the “Advisers Act”).
Section 205(a)(1) of the Advisers Act and Rule 205-3 thereunder generally prohibit registered investment advisers from charging performance fees to certain private funds unless the investors in the fund meet the definition of qualified client. In order to be a qualified client under Rule 205-3, among other possibilities, a natural person must (i) have at least $1 million in assets under management with the adviser immediately after entering into the advisory contract (the “assets-under-management test”) or (ii) be reasonably believed by the adviser, immediately prior to entering into the advisory contract, to (A) have a net worth (including assets held jointly with such person’s spouse) of more than $2 million (excluding the value of a natural person’s primary residence and debt secured by the primary residence up to the estimated fair market value of the primary residence at the time the advisory contract was entered into) (the “net-worth test”) or (B) be a “qualified purchaser” as defined in Section 2(a)(51)(A) of the Investment Company Act of 1940 (the “Investment Company Act”).
According to the IM Guidance Update, investment advisers “that operate a single advisory business through related investment advisers formed as separate legal entities that are registered jointly with the [SEC]” (in reliance on the no-action letter issued to the American Bar Association by SEC staff on January 18, 2012, as discussed in the February 21, 2012 Investment Management Regulatory Update) (such related entities together, a “Firm”), may aggregate the investments of an investor who is a client of more than one private fund managed by the Firm in order to determine such investor’s status as a qualified client. Thus, according to the IM Guidance Update, an investor that “may have invested less than $1,000,000 in any one private fund, but more than $1,000,000 collectively in the private funds” that are managed by the Firm, may be considered a qualified client for purposes of Rule 205-3.
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