Definition of a Qualified Client

In evaluating any investment opportunity, it is important to understand your investor status under the Securities Exchange & Commission (SEC). The SEC is the federal governing body that oversees both public and private investments and capital markets in the United States. They have the authority to set rules and regulations for entities including but not limited to companies, funds, investment advisors, and investors.

Many alternative investments, in particular hedge funds or private equity funds, require investors to meet the SEC's guidelines to be considered a qualified client. What are those guidelines?

According to the SEC, Rule 205-3 under the Investment Advisers Act of 1940 an investment advisor can be charged a performance fee if their client is qualified.¹ In a nutshell, this client (individual or company) must meet one of the following requirements:

1. The advisor should be managing a minimum of $1 million in AUM (assets under management) of the client immediately upon fully executing an investment advisory agreement between both parties.²
2. The advisor has sufficient information to believe that just prior to executing an agreement this client has a net worth of more than $2.1 million. If this is an individual the $2,100,000 threshold can be calculated including assets held in joint ownership with your life partner. Make sure to keep in mind the net worth calculation excludes a primary residence.³
3. Once an advisory agreement is brought about, you meet the criteria of a qualified purchaser as defined in section 2(a)(51) of the Investment Company Act. A qualified purchaser is held to a significantly higher threshold than an accredited investor.⁴
4. You have a position of an executive officer, director, trustee, general partner, or serving in a comparable capacity with or as the investment advisor.⁵
5. You are employed by the advisor for a minimum of one year and directly involved in the investment tasks. Employees such as ones only performing secretarial duties will not qualify under this criterion.⁶

A detailed explanation of the criteria required to be a qualified client can be found here.

It is worth noting, as we are currently in 2021, the Dodd-Frank Wall Street Reform and Consumer Protection Act allows the SEC to adjust the net worth and AUM threshold for inflation every five years following July 21, 2011.⁷ This adjustment is based on the Personal Consumption Expenditures Chain-Type Price Index, which is released each month by the U.S. Department of Commerce, Bureau of Economic Analysis.

Qualified clients should undertake proper due diligence, if applicable take the time to ensure your investment professional is registered via the Investment Adviser Public Disclosure site. In addition, to verifying if an investment advisor comes up in the SEC Action Lookup—Individuals site.