Qualified Client Definition (Rule 205-3): 2026 Thresholds and History

What the law says: the ban and its exceptions

Section 205(a)(1) of the Investment Advisers Act of 1940, 15 U.S.C. 80b-5(a), says that “No investment adviser registered or required to be registered with the Commission shall enter into, extend, or renew any investment advisory contract” if the contract “provides for compensation to the investment adviser on the basis of a share of capital gains upon or capital appreciation of the funds or any portion of the funds of the client”. That is a performance fee. A flat fee on assets, however large, is not.

Because the sentence is limited to advisers “registered or required to be registered with the Commission”, it does not by its terms reach advisers registered only with a state, or exempt reporting advisers (our reading). The SEC lists 6,778 exempt reporting advisers in the same October 2026 data release, and they file a Form ADV with no Item 5, so there is no fee question to count (our count). State-registered advisers follow state rules, which we did not source and which you should check with your state securities regulator.

Section 205(b) removes five kinds of contract from the ban, and Section 205(e) lets the SEC exempt a person who, in the statute's words, “does not need the protections of subsection (a)(1)”. All of this is in the statute:

Source: 15 U.S.C. 80b-5(a), (b) and (e), U.S. Code 2024 edition, govinfo.gov. “Why” column is our reading.

The rule text, from the eCFR

The rule is 17 CFR 275.205-3 (eCFR, current to October 7, 2026). Paragraph (a) says the Section 205(a)(1) ban “will not be deemed to prohibit” a contract with compensation on “a share of the capital gains upon, or the capital appreciation of, the funds” of a client, provided the client “is a qualified client”. Paragraph (d)(1) defines the term in three parts:

• (d)(1)(i), assets with the adviser. “A natural person who, or a company that, immediately after entering into the contract has, under the management of the investment adviser, at least the applicable dollar amount specified in the most recent order”.
• (d)(1)(ii), net worth or qualified purchaser. A person the adviser “reasonably believes, immediately prior to entering into the contract”, either “Has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than the applicable dollar amount specified in the most recent order”, or “Is a qualified purchaser as defined in section 2(a)(51)(A) of the Investment Company Act of 1940”. For net worth, “The person's primary residence must not be included as an asset”, and mortgage debt up to the home's value is not a liability, except for any increase in the 60 days before.
• (d)(1)(iii), insiders. A natural person who is an “executive officer, director, trustee, general partner, or person serving in a similar capacity, of the investment adviser”, or an employee who “participates in the investment activities” of the adviser and has done so for at least 12 months.

The dollar figures are not written in the rule. Since the SEC's November 2021 amendment (Release IA-5904, 86 FR 62473) the rule refers to “the most recent order”, defined as “the most recently issued Commission order in accordance with paragraph (e) of this section and as published in the Federal Register”. Paragraph (e) sets the schedule: orders “on or about May 1, 2026, and approximately every five years thereafter”, computed from the Personal Consumption Expenditures price index with bases of $750,000 and $1,500,000, rounded to the nearest $100,000. The first-time reader trap: a law-firm alert from before mid-2026 shows numbers that no longer apply.

Three more paragraphs matter for a fund investor:

• Look-through, (b). For “a private investment company”, a registered investment company or a business development company, “each equity owner of any such company” is “considered a client” (except the adviser itself and owners not charged a capital-gains fee). A private investment company is one that would be an investment company but for Section 3(c)(1).
• Transition, (c)(1). A registered adviser that met the conditions in force when it signed stays compliant, but if a person “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”. A new investor in an old fund is tested at today's numbers.
• Gifts and divorce, (c)(3). A transfer of an interest “by gift or bequest, or pursuant to an agreement related to a legal separation or divorce” does not make the recipient a new party.

Every threshold since 1985

The rule dates from 1985. In its October 2026 proposal the SEC describes the original test as “at least $500,000 in assets under management with the adviser” or a net worth of “at least $1,000,000”. Every later number comes from an SEC order or rule published in the Federal Register:

Source: Federal Register documents 98-19373, 2011-17854, 2016-14450, 2021-13192, 2026-08480 and 2026-20474. The rule was amended in February 2012 (Release IA-3372, 77 FR 10358) to write in the 2011 amounts and again in November 2021 to point to “the most recent order”.

Two readings (our arithmetic). The assets test rose 86.7% from 1998 to 2026 and the net worth test 80.0%; from the 1985 original, 180.0% and 170.0%. And the 2016 order is the one many summaries skip: the inflation calculation was smaller than the rounding step, so the assets test stayed at $1,000,000 while the net worth test moved by one step to $2,100,000.

Each order applied only to contracts entered into on or after its effective date. The 2026 order says the adjustments “would not generally apply retroactively” to existing contractual relationships, “subject to the transition rules incorporated in rule 205-3”. The notice of intent was Release IA-6955 of March 27, 2026, and the SEC received no hearing requests by the April 27, 2026 deadline.

Our own guide on the investor tests, qualified purchaser vs accredited investor, gives the 2021 and 2026 pair; this page adds the three earlier steps and the 2016 order.

Qualified client, accredited investor and qualified purchaser in one table

The three labels come from three laws and are tested in different ways. This is the only comparison you need:

Source: 17 CFR 275.205-3, 17 CFR 230.501(a)(5) and (6), 15 U.S.C. 80a-2(a)(51)(A), Federal Register 2026-08480 and 2026-20474. Accredited investor has other routes (entities, directors, and so on); we show the individual tests.

A qualified purchaser is a qualified client by rule, because Rule 205-3(d)(1)(ii)(B) lists it. The reverse is not true: a household with $3,000,000 of net worth excluding the home and $3,000,000 of investments is a qualified client (net worth above $2,700,000) but not a qualified purchaser (investments below $5,000,000) (our arithmetic). And a person with $1,200,000 of net worth excluding the home is accredited but not a qualified client, unless the adviser already manages $1,400,000 for them: the gap the SEC itself describes in its October 2026 proposal.

“Knowledgeable employee” is a different rule

Two insider tests are easy to confuse. Rule 3c-5 under the Investment Company Act defines a “Knowledgeable Employee” so that fund insiders can be left out when counting 3(c)(1) beneficial owners or checking that a 3(c)(7) fund is owned only by qualified purchasers. It names an “Executive Officer, director, trustee, general partner, advisory board member, or person serving in a similar capacity”, or an employee who participates in investment activities and has done so for at least 12 months. Rule 205-3(d)(1)(iii) has its own, narrower list with no “advisory board member” and it applies to the adviser's people, not the fund's. The SEC's 2026 proposal calls the Rule 205-3 category “similar to” the Rule 3c-5 one, not the same.

What Form ADV shows: a census of performance-fee advisers

Form ADV Part 1A Item 5.E asks how the adviser is paid, with seven boxes: (1) a percentage of assets, (2) hourly charges, (3) subscription fees, (4) fixed fees, (5) commissions, (6) performance-based fees, (7) other. We counted box (6) in three SEC data files of registered advisers (script and output saved with this page). Exempt reporting advisers do not answer Item 5.

Source: SEC, Information About Registered Investment Advisers and Exempt Reporting Advisers, files posted December 2025, June 2026 and October 2, 2026; counts are ours. The October zip contains a CSV named ia09012026.csv.

From December 2025 to October 2026 the registered count rose by 726 and the performance-fee count by 192 (our arithmetic). The share is stable at about 36%. Where the 6,152 sit (October 2026 file):

Source: SEC Form ADV data file posted October 2, 2026, Items 5.D(b)(1), 5.E(6), 5.F(2)(c) and 7.B; our arithmetic. “High net worth individual” on Form ADV is, per the Glossary as quoted by the SEC, an individual who is a qualified client or a qualified purchaser.

Three findings. First, performance fees are the private fund business: 5,194 of the 6,152 advisers (84.4%) run private funds, and those advisers report 62,773 private funds against 7,019 for all other advisers (89.9% of the total, our arithmetic). Second, only 1,303 advisers report performance fees and have at least one client counted as a high net worth individual, which is the Form ADV proxy for qualified clients, and 510 report performance fees with neither private funds nor such clients. Third, the median performance-fee adviser with funds reports 4 private funds. The file also gives gross private fund assets of $28.4 trillion for the performance-fee advisers against $2.4 trillion for the others (our sum). Item 5.E(6) says only that the adviser charges performance fees: advisers to 3(c)(7) funds or to non-U.S. clients can tick it without relying on Rule 205-3.

What the SEC proposed on October 6, 2026

In File No. S7-2026-28 (Release IA-7022, 91 FR 63676) the SEC proposes to amend the “qualified client” definition “to include investors that satisfy the ‘accredited investor’ definition under Regulation D” and it would drop the separate net worth test and the assets-under-management test. The SEC gives the reason in plain terms: an investor may be accredited, and so able to buy into a Section 3(c)(1) fund, yet not meet the definition of a qualified client “necessary to invest in a section 3(c)(1) fund with a performance fee”. A private investment company itself could not qualify only by being accredited; each of its equity owners charged a fee would be tested. The same release would widen performance fees for registered funds and business development companies. Nothing changes until a final rule; comments are due December 7, 2026.

Verdict: which side of the line you are on

• Net worth over $2,700,000 without your home, or $1,400,000 with the adviser, or $5,000,000 in investments: you are a qualified client on any contract signed from June 29, 2026. You can be charged carry in a 3(c)(1) fund.
• Accredited but below those numbers: you can buy into a 3(c)(1) fund that charges no performance fee. If the fund charges carry, it should be asking for qualified client status, and the 2026 proposal, if adopted, would change that.
• Qualified purchaser: the test is moot for you. You qualify for both, and a 3(c)(7) fund is outside the ban anyway under Section 205(b)(4).
• Offered a deal by a sponsor that is not a registered adviser: the Section 205(a)(1) ban applies only to advisers “registered or required to be registered with the Commission” (our reading). A sponsor of real estate syndications may be neither. Look for the sponsor on the SEC's adviser search before relying on any label.

What a reader can do with this

• Find which test the document uses. The subscription booklet will name qualified client, accredited investor, qualified purchaser, or all three. Check the dollar figure against $1,400,000 and $2,700,000 for contracts from June 29, 2026, not the 2021 amounts in older alerts.
• Look up the adviser. The sponsor's Form ADV is public on the SEC's adviser search. Item 5.E(6) shows whether it reports performance fees; Schedule D Section 7.B.(1) lists each private fund and, for 3(c)(1) funds, whether sales are limited to qualified clients.
• Do the home arithmetic. For the net worth test the primary residence is not an asset and mortgage debt up to its value is not a liability. Debt above the home's value counts against you.
• Know what is not in the rule. A fund that is a 3(c)(7) fund, or a client who lives outside the United States, falls under Section 205(b), not Rule 205-3. For the other investor tests see qualified purchaser vs accredited investor, and for how carry works in funds see how to invest in private equity and our guide to fiduciary financial advisors.
• Watch the open SEC file. S7-2026-28 closes for comments on December 7, 2026.

FAQ

Sources, read and saved on October 10, 2026: 17 CFR 275.205-3, 230.501 and 270.3c-5 from the eCFR (current to October 7, 2026); 15 U.S.C. 80b-5 and 80a-2 (U.S. Code 2024 edition, govinfo.gov); Federal Register documents 98-19373 (63 FR 39022, 1998 final rule), 2011-17854, 2016-14450, 2021-13192 and 2026-08480 (inflation orders), 2012-4046 and 2021-24525 (rule amendments), 2026-06229 (notice of intent) and 2026-20474 (proposal S7-2026-28); SEC Form ADV Part 1A (blank form); SEC Form ADV data files for registered and exempt reporting advisers (December 2025, June 2026, October 2, 2026). Counts and percentages are our arithmetic; the script is saved with this page. This is analysis of public documents, not investment, legal or tax advice.