This article is the second of a three-part series discussing trusts in the context of certain common investor thresholds for investment in private securities. This article will examine trusts as “qualified clients” under the Advisers Act.

What is the Advisers Act and Who Does It Affect?

Broadly speaking, the Advisers Act regulates the activities of “investment advisers.” The Advisers Act defines an investment adviser as an individual or entity that provides advice as to securities for compensation. This includes advising clients on the value of securities or the advisability of buying or selling them.

The Advisors Act requires that investment advisers register with the SEC or operate under an exemption if they provide investment advice as to securities for compensation.

Many investment advisers charge what’s known as the “2/20” fee model, where they receive a 2% management fee as a fee on all assets under management and a 20% performance allocation as a fee on profits. These fees place an individual or firm squarely within the Advisers Act’s definition of an investment adviser, meaning they must comply with the registration requirements—unless exempt.

The “Qualified Client” Requirement

The Advisers Act prohibits SEC-registered investment advisers from charging performance fees (e.g., 20% performance allocation) unless the investor is a “qualified client” as defined in the Advisers Act. This is in contrast to the rules for many state-registered investment advisers (which, depending on the state, may or may not require a state-registered investment adviser to charge performance-based fees to do so of qualified clients) and exempt reporting advisers.

A qualified client can be one of the following:

1. Qualified Purchaser Under the Investment Company Act:
   If a trust is already classified as a qualified purchaser under the Investment Company Act, they are automatically considered a qualified client under the Advisers Act. See part 3 of this 3-part series: “Trusts as Qualified Purchasers.”
2. Assets Under Management Test:
   A trust can qualify as a client if, after entering into an advisory contract with the trust, the SEC-registered adviser manages at least $1.1 million of the trust’s money under an advisory contract.
3. Net Worth Test:
   Alternatively, an SEC-registered investment adviser can qualify an investor if they reasonably believe, immediately before entering into an advisory contract with a trust, that the trust has a net worth exceeding $2.2 million.

Advisers should structure trusts accordingly, ensuring they comply with the Advisers Act and other relevant laws, such as the Securities Exchange Act of 1940. By meeting the qualified client requirements, trusts can better position themselves to take advantage of opportunities in private markets, including investments in private equity vehicles and hedge funds.

Conclusion:

As private securities continue to grow and wealth transfers increase, understanding the qualified client threshold is essential for trusts seeking to invest in these assets. Trust advisers must be diligent to ensure a trust is able to participate in certain private securities or engage an investment adviser under an advisory contract under the Advisers Act and other related regulations to facilitate both wealth transfer and access to alternative investments.

For more information, please see the article prepared by Andrew Rosell, Nick Curley, and Sarah Ghaffari, SEC Considerations – Investments in Private Securities.