Somewhat unexpectedly, the Securities and Exchange Commission (SEC) announced that it is considering expanding the ability of registered funds to pay performance fees to their investment advisers. Although details have not been released, the proposal could be significant to the fund industry, especially for alternative managers.
Current Restrictions on Performance Fees
Currently, registered funds may only pay performance fees based on profits or gains if the registered fund is sold only to investors who meet the qualified client (QC) definition in Rule 205-3 under the Investment Advisers Act of 1940 (i.e., individuals who have a net worth exceeding $2.7 million). This restriction has deterred many alternative fund managers from launching retail registered funds (i.e., funds that are offered to retail investors that do not meet the QC threshold). Alternative managers are generally reluctant to launch products not subject to performance fees since these products would have lower or differentiated fees from their flagship hedge or private equity funds that pay performance fees.
Potential Impact on the Registered Fund Market
If proposed and adopted, removal or liberalization of the performance fee restriction on registered funds should generate significant growth in retail product launches, particularly by alternative managers accustomed to performance-based compensation. The SEC publicly stated that the goal of the proposal would be to “open more opportunities for retail investors” to invest in funds with exposure to private markets. That indeed could be the case.
If you have any questions, or would like additional information, please contact one of the attorneys on our Investment Funds team.
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