SEC proposes to modernize performance fee rules and expand accredited investor designations

In brief

• The SEC proposes to modernize Rule 205-3 under the Advisers Act by establishing two channels for performance-based compensation: an accredited investor channel (available to all fund types and non-fund clients) and a fund board channel (available to regulated funds meeting specified governance conditions).
• Under the proposal, the accredited investor channel replaces the existing $2.7M net worth and $1.4M AUM thresholds with the lower Regulation D accredited investor standard.
• The fund board channel permits regulated funds to pay performance fees up to 20% of net capital gains (realized or unrealized), subject to Rule 0-1(a)(7) governance standards and a board best-interest determination with written findings on strategy, valuation and investor protection.
• All advisers must reclassify clients on Form ADV under a revised “high net worth individual” definition, regardless of whether they charge performance fees.
• Five concurrent orders would designate additional professional credentials as qualifying for accredited investor status—including a new FINRA-administered investor exam, CPA, CFA, CFP and FINRA Series 79/86-87 licenses—creating knowledge-based pathways to performance-fee eligibility.
• New disclosure requirements would apply to all regulated funds charging performance fees, including a prospectus fee table line item, management discussion with graphical illustrations and particularized Form N-CSR reporting.
• Comments on the Rule 205-3 proposal are due December 7, 2026; comments on each proposed accredited investor designation order are due December 4, 2026.

Background

On September 30, 2026, the SEC proposed amendments to Rule 205-3 under the Advisers Act, marking the most significant revision to the performance fee framework in decades. Section 205(a)(1) of the Advisers Act generally prohibits performance-based compensation. Over the years, however, Congress and the Commission have layered in exceptions, including fulcrum fees for registered investment companies, a 20% cap on realized gains for business development companies (BDCs), a carve-out for 3(c)(7) private funds, and the “qualified client” safe harbor (currently $2.7M net worth or $1.4M AUM).

Two channels to performance fees

The proposal establishes two channels for performance-based compensation:

• Accredited investor channel. Available for use with all registered and non-registered fund types and non-fund clients. Replaces existing net worth and AUM thresholds with the Regulation D accredited investor definition while retaining the qualified purchaser and knowledgeable employee prongs.
• Fund board channel. Available for use with regulated funds (mutual funds, closed-end funds, ETFs, interval funds and tender-offer funds registered under the Investment Company Act, and BDCs). A regulated fund satisfies the qualified client definition at the entity level - with no investor-level look-through—by meeting three conditions: (1) a 20% fee cap on net capital gains; (2) Rule 0-1(a)(7) governance standards and (3) a board best-interest determination with written findings.

Qualified client definition overhaul

The proposal replaces the existing net worth ($2.7M) and AUM ($1.4M) tests with the accredited investor definition under Rule 501 of Regulation D. The accredited investor thresholds are significantly lower - net worth exceeding $1M (excluding primary residence) or income exceeding $200K ($300K joint) - which would expand eligibility to an estimated 17.1 million additional US households, compared to 7.2 million US households that currently meet the qualified client thresholds.

Look-through. For advisers to 3(c)(1) private funds, each equity owner must independently qualify as a qualified client unless that owner is not charged a performance fee. For advisers to regulated funds using the fund board channel, by contrast, the fund satisfies the qualified client definition at the entity level—no investor-level look-through is required.

Current framework vs. proposed framework

Current qualified client tests	Proposed qualified client tests
Net worth ≥ $2.7M (excluding primary residence)	Accredited investor under Rule 501 of Reg D (net worth > $1M excl. primary residence or income > $200K/$300K joint)
AUM with the adviser ≥ $1.4M	AUM test eliminated
Qualified purchasers	Qualified purchasers (retained)
Knowledgeable employees	Knowledgeable employees (retained)
N/A	Fund board channel (new – regulated funds meeting the three enumerated conditions)

 

Concurrent accredited investor designation orders

The Commission also published five orders under Rule 501(a)(10) under the Securities Act proposing to designate additional professional credentials as qualifying for accredited investor status. Unlike the Rule 205-3 proposal, which would incorporate accredited investor status into the qualified client definition, these orders create a direct path from credential to performance-fee eligibility.

• FINRA Accredited Investor Exam (Release No. 33-11445). Administered by FINRA and modeled largely on FINRA’s Securities Industry Essentials (also known as the SIE) exam. Approximately 75 multiple-choice questions; 2 hours; ~$100. No experience required; the exam would be open to anyone age 18 years or older and an individual could take the examination without being associated with a FINRA member firm; valid for 10 years with option to retake. Verification via FINRA process (TBD). Status: New – to be developed.
• CPA License (Release No. 33-11446). Administered by State Accountancy Boards/AICPA/NASBA. Verification via state board registries. Status: Existing credential.
• CFA Charter (Release No. 33-11447). Administered by CFA Institute. Verification via CFA Institute directory. Status: Existing credential.
• CFP® Certification (Release No. 33-11448). Administered by CFP Board. Verification via CFP Board lookup tool. Status: Existing credential.
• FINRA Investment Banking Representative License (Series 79) and the FINRA Research Analyst License (Series 86 and 87) (Release No. 33-11449). Administered by FINRA. Verification via FINRA BrokerCheck. Status: Existing credentials.

Fund board channel: Three conditions

Condition 1: 20% fee cap. Performance fees may not exceed 20% of net capital gains or appreciation, extending the BDC statutory exception to cover unrealized gains. The 20% cap is a ceiling, not a target--boards should evaluate whether a lower rate is appropriate.

Condition 2: Fund governance standards. The fund must satisfy Rule 0-1(a)(7) under the Investment Company Act, which requires a majority-independent board, independent director self-nomination, independent counsel, annual board self-evaluation, quarterly independent director sessions, and authority for independent directors to hire staff and retain advisers.

Condition 3: Board best-interest determination. The board, including a majority of independent directors, must determine that the performance fee is in shareholders’ best interests and document written findings addressing three areas: (1) appropriateness for the fund’s strategy and valuation practices, particularly for Level 3 (most illiquid and hardest-to-value) assets; (2) calculation basis – realized gains, unrealized gains or both, plus the measurement period; and (3) investor protections – preferred returns, hurdle rates, high-water marks or loss carryforward, or an explanation of why no such features are needed. The board must make or reaffirm these findings annually as part of its Section 15(c) review (annual process by which a fund’s independent directors must evaluate and approve the fund’s investment advisory contract).

New fund disclosure requirements

The proposal introduces disclosure requirements for all regulated funds charging performance fees, not just funds using the new fund board channel but also fulcrum fee funds and BDCs under existing exceptions. For BDCs, the incremental burden should be modest. BDCs already disclose performance fees in their periodic reports, and many already break out incentive fees in their fee tables, leaving the new management discussion items as the principal new work.

Prospectus fee table (Forms N-1A/N-2): Funds must add a separate “Performance Fees” line item below Management Fees, accompanied by a footnote describing the calculation basis and a cross-reference to a more detailed discussion elsewhere in the prospectus. The expense example must also reflect performance fees.

Management discussion: Fee rate and calculation basis (realized/unrealized gains, income); whether calculated before or after other expenses; measurement period; description of investor protections (hurdle rates, high-water marks, preferred returns, loss carryforward); and a graphical representation illustrating fee impact across hypothetical return scenarios.

Form N-CSR: Particularized disclosure addressing the board’s rationale for approving the performance fee, mirroring the written findings required by the board best interest determination.

Conforming amendments

Rule 203A-3: The expanded qualified client definition broadens the “excepted person” category, potentially removing some investment adviser representatives (IARs) from state licensing requirements.

Form ADV, Part 1A: The “high net worth individual” definition under Item 5(D)(b) changes to reflect the accredited investor standard—approximately 64% of advisers will need to reclassify clients regardless of whether they charge performance fees.

Compliance timeline

• Fund board channel: Effective immediately upon adoption; funds would be required to comply with all disclosure requirements from the outset.
• Accredited investor channel: Effective immediately upon adoption.
• Disclosure amendments (Forms N-1A, N-2 and N-CSR): 12 months after effectiveness for funds not using the fund board channel.
• Form ADV reclassification: Effective immediately upon adoption.

What this means for advisers and fund boards 

If adopted, this rule would mark a fundamental shift in how regulated funds and clients can compensate advisers.

For investment advisers

• Evaluate your channel options and reclassify clients. Consider whether the fund board channel, the accredited investor channel or a combination of both, best fits your business model. Advisers may use different channels for different client relationships. The revised qualified client definition requires reclassification of existing clients, and the “high net worth individual” category in Form ADV will change for all advisers with individual clients.
• Assess IAR licensing and fund disclosures. The expanded “excepted person” definition could affect state-level IAR licensing obligations (i.e., certain supervised persons of SEC-registered investment advisers may not have to be registered as IARs). For advisers to regulated funds, prepare for new prospectus fee table, management discussion and Form N-CSR requirements—including the graphical representation. For most BDCs, this should be a lighter lift.
• Update investor verification procedures. For credential-based accredited investors, verification expands beyond income and net-worth documentation to credential lookups through FINRA BrokerCheck, the CFA Institute directory, the CFP Board lookup tool, and state accountancy board registries.

For fund boards

• Assess strategic fit and governance readiness. Evaluate whether performance-based compensation aligns with the fund’s strategy and investor base and confirm compliance with Rule 0-1(a)(7) governance standards. Develop templates for the required written findings addressing strategy appropriateness, valuation robustness and investor protection.
• Scrutinize valuation and investor protection. Fees on unrealized gains introduce risks of fee reversal and NAV compression. Critically assess valuation policies, particularly for Level 3 assets. Fund boards should also discuss with advisers and auditors the considerations identified in the SEC Staff’s September 2026 Statement on Fair Value Measurement and Disclosure Considerations for Private Assets, which addresses valuation governance, the role of independent valuation and disclosure of methodologies and uncertainties for private asset holdings. Although no specific investor protection measure is mandated, boards that forgo high-water marks, hurdle rates or similar features must document why the arrangement remains in shareholders’ best interests.

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