Section 205(a)(1) of the Investment Advisers Act generally prohibits an investment adviser from collecting performance based compensation that is based on a share of capital gains on, or capital appreciation of, a client’s funds or assets under management. The Securities and Exchange Commission (“SEC”) adopted Rule 205-3 to provide exceptions to this prohibition if the client’s assets under management exceeded a certain threshold (the “assets-under-management test”) or if the adviser reasonably believe the client had a certain minimum net worth  (the “net worth test”). Currently, the asset-under-management test and net worth test thresholds are $750,000 and $1.5 million, respectively.

The Dodd-Frank Act (the “Act”), which was signed into law on July 21, 2010, amended Section 205(e) to require the SEC to adjust the dollar amount tests included in the rules issued pursuant to Section 205(e) for inflation by July 21, 2011 and every five years thereafter. Furthermore, the Act required the net worth test dollar amount to exclude the value of a person’s primary personal residence.

On May 10, 2011, the SEC issued a proposed amendment to increase the dollar amounts for the assets-under-management test and net worth test under Rule 205-3 to $1 million and $2 million respectively. These thresholds will be indexed for inflation every five years thereafter. Furthermore, the net worth test will be amended to exclude the value of the investor’s primary personal residence.

To view the SEC’s proposed amendment click here.