• The Rule proposal would substantially broaden who would be a “qualified client” and thus eligible to be charged performance-based compensation (carried interest).
• Any investor the adviser reasonably believes to be an accredited investor at the time of investment would be a qualified client under the revised rule.
• The $2.7 million net worth test, the $1.4 million assets-under-management test and the periodic inflation adjustments under the current rule would all be eliminated. Existing contracts would be grandfathered, but new investors would be tested under the new rule.
• The proposal is not a final rule; comments are due by December 7, 2026. Managers must keep their current investor qualification procedures in place unless and until a final rule is adopted.

On September 30, 2026, the Securities and Exchange Commission (SEC) voted to propose amendments to Rule 205-3 under the Investment Advisers Act of 1940 (the Advisers Act), titled “Investment Adviser Performance-Based Compensation Modernization” (Release No. IA-7022; File No. S7-2026-28). The proposal was published in the Federal Register on October 6, 2026, and comments are due by December 7, 2026.

The proposal has two main parts. First, it would let advisers charge performance fees to registered funds and business development companies on new terms. Second, and most important for private fund sponsors, it would fold the “accredited investor” definition in Regulation D into the “qualified client” definition. This would largely end the long-standing gap between the investors a private fund may accept for Regulation D purposes and the investors from whom a sponsor may collect carried interest or performance fees.

Key Changes Affecting Private Fund Managers

1. Accredited investors would become qualified clients. A natural person or company would be a qualified client if the adviser reasonably believes, when the advisory contract is entered into, that the person is an accredited investor under Rule 501(a) or a qualified purchaser. The prong for knowledgeable employees, meaning executive officers, directors, general partners and certain investment personnel with at least 12 months of experience, would stay in place.
2. The net worth and assets-under-management tests would be removed. The current thresholds would be deleted: $2.7 million of net worth and $1.4 million of assets under management with the adviser (both inflation-adjusted as recently as June 29, 2026). The five-year inflation-adjustment mechanism in Rule 205-3(e) would be deleted as well. For individuals, the operative test would become the accredited investor standard: net worth over $1 million excluding the primary residence, or income of $200,000 ($300,000 with a spouse or spousal equivalent), or a qualifying professional credentials.^[1]
3. The look-through rule for 3(c)(1) funds would be restated, with the same effect. A Section 3(c)(1) fund could not become a qualified client just because the fund itself is an accredited investor. Instead, the fund would be a qualified client only if each equity owner that bears a performance fee is itself a qualified client. The explicit carve-out for the adviser entering into the contract would be dropped, because advisers are accredited investors in their own right. Section 3(c)(7) funds remain outside the performance fee prohibition under the existing statutory exception in Section 205(b)(4).
4. Existing arrangements would be grandfathered. Contracts entered into in compliance with the rule as in effect at the time would remain compliant. However, any new party, including a new investor in an existing 3(c)(1) fund, would be tested under the rule in effect when that party is admitted. Transfers by gift, bequest or divorce-related agreement would not cause the transferee to “become a party.”
5. Conforming changes would be made. The federal rules that cross-reference the qualified client definition would also change. These are the “investment adviser representative” (“IAR”) definition in Rule 203A-3 (expanding the definition of “excepted person” for purposes of investment for IAR registration requirements), the brochure supplement delivery exception in Rule 204-3, and the definition of “high net worth individual” for Form ADV reporting.

Practical Implications

• A single eligibility standard for 3(c)(1) funds. Most 3(c)(1) funds offered under Rule 506(b) or 506(c) already limit investors to accredited investors. Under the proposal, sponsors would no longer need to run a separate qualified client analysis for investors who may be charged performance-based fees or allocations. The SEC presents this as a cost reduction for subscription and onboarding processes.
• A larger pool of investors who can pay carry. The SEC estimates that about 17.1 million U.S. households qualify as accredited investors but do not meet the current $2.7 million net worth test, and that these households would become qualified clients. Sponsors could admit these investors to existing or new 3(c)(1) funds on full carry terms, rather than placing them in fee-only classes or excluding them entirely.
• Expansion of investor pool for state-level exempt advisers. For private fund advisers relying on a state level private fund adviser exemption that includes a qualified client requirement on certain funds, the rule will expand the universe of permissible investors their funds may accept.
• Some entity investors could technically lose eligibility. Some entities currently qualify through the $2.7 million net worth or $1.4 million assets-under-management tests but do not meet the more-than-$5 million assets or investments tests that apply to many entities under Rule 501(a). Those entities would no longer be qualified clients for new contracts. The SEC believes this group is small and has requested comment on it. Also, as private funds typically limit all investors to accredited investors, the practical impact of this should be minimal.

Recommended Next Steps

• Review subscription documents and investor questionnaires, and plan to simplify the qualified client representations if the rule is adopted. Until then, keep the current qualified client verification in place, because the proposal is not yet effective and no effective date has been set.
• Find entity investors that qualify only under the net worth or assets-under-management tests and assess how the change would affect future closings and successor funds.
• Consider whether fee-only or non-carry classes, feeder structures, or investment minimums built around the current thresholds might be simplified.

Foley Hoag’s Private Funds team is monitoring this rulemaking and is available to discuss how the proposal may affect your fund structures, offering documents and comment strategy.

This alert is for general informational purposes only and does not constitute legal advice. The amendments described are proposed and may change before any final adoption.

1. In addition to the rule proposal discussed in this alert, the SEC has also published notices to expand professional certifications by which an individual may be considered an “accredited investor,” including a new “accredited investor exam.” Comments on these notices are due no later than December 4, 2026. ↑