IM Guidance Update

November 2013 | No. 2013-10

US Securities and Exchange Commission

 Division of Investment Management

STATUS OF CERTAIN PRIVATE FUND INVESTORS AS QUALIFIED CLIENTS

The Dodd-Frank Act, which resulted in the registration of many investment advisers to 

hedge, private equity, and other private funds, significantly increased the population of 

investment advisers to these funds registered with the Commission.1 The Division has 

received inquiries concerning the status of certain private fund investors as “qualified 

clients” under Advisers Act rule 205-3 from investment advisory firms that operate a 

single advisory business through related investment advisers formed as separate legal 

entities that are registered jointly with the Commission in reliance on the no-action letter 

issued by the staff on January 18, 2012 to the American Bar Association (each group, 

a “Firm”). Rule 205-3 provides an exemption from section 205(a)(1) of the Advisers 

Act, which prohibits an investment adviser from entering into an investment advisory 

contract that provides for compensation to the adviser on the basis of a share of capital 

gains upon or capital appreciation of the client’s funds. An investment adviser may 

charge such a fee under rule 205-3 if the client—including investors in certain private 

funds—is a “qualified client” as defined in the rule. An investor is a qualified client if, 

among other ways to qualify, the investor, “immediately after entering into the contract 

has at least $1,000,000 under the management of the investment adviser.”

Firms have asked whether they may aggregate the investments of certain investors 

when determining whether the investors are qualified clients as defined in rule 205-3. 

In these cases the related investment advisers that comprise a Firm collectively advise 

two or more different private funds, each with its own investors. When determining if 

an investor is a qualified client as defined in rule 205-3 and is therefore eligible to be 

charged performance-based compensation, Firms have asked whether they may 

aggregate the investor’s investments in all of the private funds advised by the related 

investment advisers that comprise the Firm. An investor may have invested less than 

$1,000,000 in any one private fund, but more than $1,000,000 collectively in the 

private funds advised by the related investment advisers that comprise the Firm. In 

this situation, consistent with the operation of a single advisory business as described 

in the no-action letter to the American Bar Association, the staff would not object if 

the Firm aggregated the investor’s investments in all of the private funds advised by 
IM GUIDANCE UPDATE 2

the related investment advisers that comprise the Firm when determining if the investor 

has at least $1,000,000 “under the management of the investment adviser,” and thus is 

a qualified client as defined in rule 205-3. 

Endnotes

1 The Dodd-Frank Act eliminated the private adviser exemption from investment 

adviser registration, which was available to investment advisers that had fewer than 

15 clients with each private fund counting as a single client.

This IM Guidance Update summarizes the views of the Division of Investment Management 

regarding various requirements of the federal securities laws. Future changes in laws or 

regulations may supersede some of the discussion or issues raised herein. This IM Guidance 

Update is not a rule, regulation or statement of the Commission, and the Commission has 

neither approved nor disapproved of this IM Guidance Update.

The Investment Management Division works to:

s protect investors

s promote informed investment decisions and 

s facilitate appropriate innovation in investment products and services 

through regulating the asset management industry.

If you have any questions about this IM Guidance Update, please contact:

Investment Adviser Regulation Office

Phone: 202.551.6999 

Email: IARDLive@sec.gov