81 FR 39985 - Order Approving Adjustment for Inflation of the Dollar Amount Tests in Rule 205-3 Under the Investment Advisers Act of 1940

SECURITIES AND EXCHANGE COMMISSION

Federal Register Volume 81, Issue 118 (June 20, 2016)

[Federal Register Volume 81, Number 118 (Monday, June 20, 2016)]
[Notices]
[Pages 39985-39986]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2016-14450]


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SECURITIES AND EXCHANGE COMMISSION

[Investment Advisers Act of 1940; Release No. IA-4421/June 14, 2016]


Order Approving Adjustment for Inflation of the Dollar Amount 
Tests in Rule 205-3 Under the Investment Advisers Act of 1940

I. Background

    Section 205(a)(1) of the Investment Advisers Act of 1940 
(``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 (also known as performance compensation or performance 
fees).\1\ Section 205(e) authorizes the Securities and Exchange 
Commission (``Commission'') to exempt any advisory contract from the 
performance fee prohibition if the contract is with persons who the 
Commission determines do not need the protections of the prohibition, 
on the basis of certain factors described in that section.\2\ Rule 205-
3 under the Advisers Act exempts an investment adviser from the 
prohibition against charging a client performance fees in certain 
circumstances when the client is a ``qualified client.'' The rule 
allows an adviser to charge performance fees if the client has at least 
a certain dollar amount in assets under management (currently, 
$1,000,000) with the adviser immediately after entering into the 
advisory contract (``assets-under-management test'') or if the adviser 
reasonably believes, immediately prior to entering into the contract, 
that the client had a net worth of more than a

[[Page 39986]]

certain dollar amount (currently, $2,000,000) (``net worth test'').\3\
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    \1\ 15 U.S.C. 80b-5(a)(1).
    \2\ Under section 205(e), 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].'' 15 U.S.C. 80b-5(e).
    \3\ See rule 205-3(d)(1)(i)-(ii); see also infra note 6 and 
accompanying text.
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    The Dodd-Frank Wall Street Reform and Consumer Protection Act 
(``Dodd-Frank Act'') \4\ amended section 205(e) of the Advisers Act to 
provide that, by July 21, 2011 and every five years thereafter, the 
Commission shall adjust for inflation the dollar amount thresholds 
included in rules issued under section 205(e), rounded to the nearest 
$100,000.\5\ The Commission last issued an order to revise the dollar 
amount thresholds of the assets-under-management and net worth tests 
(to $1,000,000 and $2,000,000, respectively, as discussed above) on 
July 12, 2011.\6\ Rule 205-3 currently codifies the threshold amounts 
revised by the 2011 Order and states that the Commission will 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 based on the 
Personal Consumption Expenditures Chain-Type Price Index (``PCE 
Index,'' published by the United States Department of Commerce).\7\
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    \4\ Public Law 111-203, 124 Stat. 1376 (2010).
    \5\ See section 418 of the Dodd-Frank Act (requiring the 
Commission to issue an order every five years revising dollar amount 
thresholds in a rule that exempts a person or transaction from 
section 205(a)(1) of the Advisers Act if the dollar amount threshold 
was a factor in the Commission's determination that the persons do 
not need the protections of that section).
    \6\ See text accompanying supra note 3; Order Approving 
Adjustment for Inflation of the Dollar Amount Tests in Rule 205-3 
under the Investment Advisers Act of 1940, Investment Advisers Act 
Release No. 3236 (July 12, 2011) [76 FR 41838 (July 15, 2011)] 
(``2011 Order''). The 2011 Order was effective as of September 19, 
2011. It applies to contractual relationships entered into on or 
after the effective date and does not apply retroactively to 
contractual relationships previously in existence.
    \7\ See rule 205-3(e).
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II. Adjustment of Dollar Amount Thresholds

    On May 18, 2016, the Commission published a notice of intent to 
issue an order that would adjust for inflation, as appropriate, the 
dollar amount thresholds of the asset-under-management test and the net 
worth test.\8\ The Commission stated that, based on calculations that 
take into account the effects of inflation by reference to historic and 
current levels of the PCE Index, the dollar amount of the assets-under-
management test would remain $1,000,000, and the dollar amount of the 
net worth test would increase from $2,000,000 to $2,100,000.\9\ These 
dollar amounts--which are rounded to the nearest $100,000 as required 
by section 205(e) of the Advisers Act--would reflect inflation from 
2011 to the end of 2015.
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    \8\ See Investment Adviser Performance Compensation, Investment 
Advisers Act Release No. 4388 (May 18, 2016) [81 FR 32686 (May 24, 
2016)]. While the dollar amount of the assets under-management test 
would not change, because the amount of the Commission's inflation 
adjustment calculation is smaller than the rounding amount specified 
under rule 205-3, the dollar amount of the net worth test would be 
adjusted as a result of Commission's inflation adjustment 
calculation effected pursuant to the rule.
    \9\ See id. at section II.A.
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    The Commission's notice established a deadline of June 13, 2016 for 
submission of requests for a hearing. No requests for a hearing have 
been received by the Commission.

III. Effective Date of the Order

    This Order is effective as of August 15, 2016. 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.\10\
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    \10\ 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 Investment Adviser Performance 
Compensation, Investment Advisers Act Release No. 3198 (May 10, 
2011) [76 FR 27959 (May 13, 2011)], at section II.B.3.
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IV. Conclusion

    Accordingly, pursuant to section 205(e) of the Investment Advisers 
Act of 1940 and section 418 of the Dodd-Frank Act,
    It is hereby ordered that, for purposes of rule 205-3(d)(1)(i) 
under the Investment Advisers Act of 1940 [17 CFR 275.205-3(d)(1)], a 
qualified client means a natural person who, or a company that, 
immediately after entering into the contract has at least $1,000,000 
under the management of the investment adviser; and
    It is further ordered that, for purposes of rule 205-3(d)(1)(ii)(A) 
under the Investment Advisers Act of 1940 [17 CFR 275.205-
3(d)(1)(ii)(A)], a qualified client means a natural person who, or a 
company that, the investment adviser entering into the contract (and 
any person acting on his behalf) reasonably believes, immediately prior 
to entering into the contract, has a net worth (together, in the case 
of a natural person, with assets held jointly with a spouse) of more 
than $2,100,000.

    By the Commission.
Brent J. Fields,
Secretary.
[FR Doc. 2016-14450 Filed 6-17-16; 8:45 am]
 BILLING CODE 8011-01-P