Performance-Based Investment Advisory Fees, 32686-32688 [2016-12167]
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Federal Register / Vol. 81, No. 100 / Tuesday, May 24, 2016 / Proposed Rules
(ii) Close conjunction means on the
page containing the description of the
warranted product, or on the page facing
that page.
(2) Any seller who offers for sale to
consumers consumer products with
written warranties by means of a catalog
or mail order solicitation shall:
(i) Clearly and conspicuously disclose
in such catalog or solicitation in close
conjunction to the description of
warranted product, or in an information
section of the catalog or solicitation
clearly referenced, including a page
number, in close conjunction to the
description of the warranted product,
either:
(A) The full text of the written
warranty; or
(B) The address of the Internet Web
site of the warrantor where such
warranty terms can be reviewed (if such
Internet Web site exists), as well as that
the written warranty can be obtained
free upon specific request, and the
address or phone number where such
warranty can be requested. If this option
is elected, such seller shall promptly
provide a copy of any written warranty
requested by the consumer (and may
provide such copy through electronic or
other means, if the warrantor has
elected the option described in
paragraph (b)(2) of this section).
(ii) [Reserved].
(d) Door-to-door sales. (1) For
purposes of this paragraph:
(i) Door-to-door sale means a sale of
consumer products in which the seller
or his representative personally solicits
the sale, including those in response to
or following an invitation by a buyer,
and the buyer’s agreement to offer to
purchase is made at a place other than
the place of business of the seller.
(ii) Prospective buyer means an
individual solicited by a door-to-door
seller to buy a consumer product who
indicates sufficient interest in that
consumer product or maintains
sufficient contact with the seller for the
seller reasonably to conclude that the
person solicited is considering
purchasing the product.
(2) Any seller who offers for sale to
consumers consumer products with
written warranties by means of door-todoor sales shall, prior to the
consummation of the sale, disclose the
fact that the sales representative has
copies of the warranties for the
warranted products being offered for
sale, which may be inspected by the
prospective buyer at any time during the
sales presentation. Such disclosure shall
be made orally and shall be included in
any written materials shown to
prospective buyers. If the warrantor has
elected the option described in
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paragraph (b)(2) of this section, the sales
representative may provide a copy of
the warranty through electronic or other
means.
By direction of the Commission.
Donald S. Clark,
Secretary.
[FR Doc. 2016–12030 Filed 5–23–16; 8:45 am]
I. Background
BILLING CODE 6750–01–P
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 275
[Release No. IA–4388; File No. S7–08–16]
Performance-Based Investment
Advisory Fees
Securities and Exchange
Commission.
ACTION: Notice of intent to issue order.
AGENCY:
The Securities and Exchange
Commission (‘‘Commission’’) intends to
issue an order that would adjust for
inflation, as appropriate, dollar amount
thresholds in the rule under the
Investment Advisers Act of 1940 that
permits investment advisers to charge
performance-based fees to ‘‘qualified
clients.’’ Under that rule, an investment
adviser may charge performance-based
fees if a ‘‘qualified client’’ has a certain
minimum net worth or minimum dollar
amount of assets under the management
of the adviser. The Commission’s order
would increase, to reflect inflation, the
minimum net worth that a ‘‘qualified
client’’ must have under the rule. The
order would not increase the minimum
dollar amount of assets under
management.
SUMMARY:
Hearing or Notification of
Hearing: An order adjusting the dollar
amount tests specified in the definition
of ‘‘qualified client’’ will be issued
unless the Commission orders a hearing.
Interested persons may request a
hearing by writing to the Commission’s
Secretary. Hearing requests should be
received by the Commission’s Office of
the Secretary by 5:30 p.m. on June 13,
2016. Hearing requests should state the
nature of the writer’s interest, the reason
for the request, and the issues contested.
Persons who wish to be notified of a
hearing may request notification by
writing to the Commission’s Secretary.
ADDRESSES: Secretary, Securities and
Exchange Commission, 100 F Street NE.,
Washington, DC 20549–1090.
FOR FURTHER INFORMATION CONTACT:
Amanda Hollander Wagner, Senior
Counsel, Investment Company
Rulemaking Office, at (202) 551–6792,
DATES:
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Division of Investment Management,
Securities and Exchange Commission,
100 F Street NE., Washington, DC
20549–8549.
SUPPLEMENTARY INFORMATION: The
Commission intends to issue an order
under the Investment Advisers Act of
1940 (‘‘Advisers Act’’ or ‘‘Act’’).1
Sfmt 4702
Section 205(a)(1) of the Advisers Act
generally prohibits an investment
adviser from entering into, extending,
renewing, or performing any investment
advisory contract that provides for
compensation to the adviser based on a
share of capital gains on, or capital
appreciation of, the funds of a client.2
Congress prohibited these compensation
arrangements (also known as
performance compensation or
performance fees) in 1940 to protect
advisory clients from arrangements that
Congress believed might encourage
advisers to take undue risks with client
funds to increase advisory fees.3 In
1970, Congress provided an exception
from the prohibition for advisory
contracts relating to the investment of
assets in excess of $1,000,000,4 if an
appropriate ‘‘fulcrum fee’’ is used.5
Congress subsequently authorized the
Commission to exempt, by rule or order,
any advisory contract from the
performance fee prohibition if the
contract is with persons who the
1 15 U.S.C. 80b. Unless otherwise noted, all
references to statutory sections are to the
Investment Advisers Act, and all references to rules
under the Investment Advisers Act, including rule
205–3, are to Title 17, Part 275 of the Code of
Federal Regulations [17 CFR 275].
2 15 U.S.C. 80b–5(a)(1).
3 H.R. Rep. No. 2639, 76th Cong., 3d Sess. 29
(1940). Performance fees were characterized as
‘‘heads I win, tails you lose’’ arrangements in which
the adviser had everything to gain if successful and
little, if anything, to lose if not. S. Rep No. 1775,
76th Cong., 3d Sess. 22 (1940).
4 15 U.S.C. 80b–5(b)(2). Trusts, governmental
plans, collective trust funds, and separate accounts
referred to in section 3(c)(11) of the Investment
Company Act of 1940 (‘‘Investment Company Act’’)
[15 U.S.C. 80a–3(c)(11)] are not eligible for this
exception from the performance fee prohibition
under section 205(b)(2)(B) of the Advisers Act.
5 15 U.S.C. 80b–5(b). A fulcrum fee generally
involves averaging the adviser’s fee over a specified
period and increasing or decreasing the fee
proportionately with the investment performance of
the company or fund in relation to the investment
record of an appropriate index of securities prices.
See rule 205–2 under the Advisers Act; Adoption
of Rule 205–2 under the Investment Advisers Act
of 1940, As Amended, Definition of ‘‘Specified
Period’’ Over Which Asset Value of Company or
Fund Under Management is Averaged, Investment
Advisers Act Release No. 347 (Nov. 10, 1972) [37
FR 24895 (Nov. 23, 1972)].
In 1980, Congress added another exception to the
prohibition against charging performance fees, for
contracts involving business development
companies under certain conditions. See section
205(b)(3) of the Advisers Act.
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Commission determines do not need the
protections of that prohibition.6
The Commission adopted rule 205–3
in 1985 to exempt an investment adviser
from the prohibition against charging a
client performance fees in certain
circumstances.7 The rule, when
adopted, allowed an adviser to charge
performance fees if the client had at
least $500,000 under management with
the adviser immediately after entering
into the advisory contract (‘‘assetsunder-management test’’) or if the
adviser reasonably believed,
immediately prior to entering into the
advisory contract, that the client had a
net worth of more than $1,000,000 at the
time the contract was entered into (‘‘net
worth test’’). The Commission stated
that these standards would limit the
availability of the exemption to clients
who are financially experienced and
able to bear the risks of performance fee
arrangements.8 In 1998, the Commission
amended rule 205–3 to, among other
things, change the dollar amounts of the
assets-under-management test and net
worth test to adjust for the effects of
inflation since 1985.9 The Commission
revised the former from $500,000 to
$750,000, and the latter from $1,000,000
to $1,500,000.10
The Dodd-Frank Wall Street Reform
and Consumer Protection Act (‘‘DoddFrank Act’’) 11 amended section 205(e)
of the Advisers Act to provide that, by
July 21, 2011 and every five years
thereafter, the Commission shall adjust
6 Section 205(e) of the Advisers Act. Section
205(e) of the Advisers Act authorizes the
Commission to exempt conditionally or
unconditionally from the performance fee
prohibition advisory contracts with persons who
the Commission determines do not need its
protections. Section 205(e) provides that the
Commission may determine that persons do not
need the protections of section 205(a)(1) on the
basis of such factors as ‘‘financial sophistication,
net worth, knowledge of and experience in financial
matters, amount of assets under management,
relationship with a registered investment adviser,
and such other factors as the Commission
determines are consistent with [section 205].’’
7 Exemption To Allow Registered Investment
Advisers To Charge Fees Based Upon a Share of
Capital Gains Upon or Capital Appreciation of a
Client’s Account, Investment Advisers Act Release
No. 996 (Nov. 14, 1985) [50 FR 48556 (Nov. 26,
1985)] (‘‘1985 Adopting Release’’). The exemption
applies to the entrance into, performance, renewal,
and extension of advisory contracts. See rule 205–
3(a).
8 See 1985 Adopting Release, supra note 7, at
Sections I.C and II.B. The rule also imposed other
conditions, including specific disclosure
requirements and restrictions on calculation of
performance fees. See id. at Sections II.C–E.
9 See Exemption To Allow Investment Advisers
To Charge Fees Based Upon a Share of Capital
Gains Upon or Capital Appreciation of a Client’s
Account, Investment Advisers Act Release No. 1731
(July 15, 1998) [63 FR 39022 (July 21, 1998)].
10 See id. at Section II.B.1.
11 Public Law 111–203, 124 Stat. 1376 (2010).
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for inflation the dollar amount
thresholds included in rules issued
under section 205(e), rounded to the
nearest $100,000.12 In May 2011, the
Commission published a release (the
‘‘May 2011 Release’’) that included a
notice of intent to issue an order
revising the dollar amount thresholds of
the assets-under-management test (from
$750,000 to $1,000,000) and the net
worth test (from $1,500,000 to
$2,000,000).13 The Commission issued
an order to revise the dollar amount
thresholds of the assets-undermanagement and net worth tests, as
described above, on July 12, 2011.14
The May 2011 Release also proposed
amendments to rule 205–3 providing,
among other things, that the
Commission would issue an order every
five years in the future adjusting the
rule’s dollar amount thresholds for
inflation.15 On February 15, 2012, the
Commission adopted these proposed
amendments, which amended rule 205–
3 in three ways to carry out the inflation
adjustment of the rule’s dollar amount
thresholds.16 First, the amendments
revised the dollar amount thresholds in
rule 205–3, in order to codify the order
the Commission issued on July 12,
2011.17 Second, the amendments added
to rule 205–3, as proposed, a new
paragraph stating that the Commission
will issue an order on or about May 1,
2016, and approximately every five
years thereafter, adjusting for inflation
the dollar amount thresholds of the
rule’s assets-under-management and net
worth tests.18 Finally, the amendments
to rule 205–3 specify the price index on
which future inflation adjustments will
be based—the Personal Consumption
Expenditures Chain-Type Price Index
12 See section 418 of the Dodd-Frank Act
(requiring the Commission to issue an order every
five years revising dollar amount thresholds in a
rule that exempts a person or transaction from
section 205(a)(1) of the Advisers Act if the dollar
amount threshold was a factor in the Commission’s
determination that the persons do not need the
protections of that section).
13 See Investment Adviser Performance
Compensation, Investment Advisers Act Release
No. 3198 (May 10, 2011) [76 FR 27959 (May 13,
2011)].
14 See Order Approving Adjustment for Inflation
of the Dollar Amount Tests in Rule 205–3 under the
Investment Advisers Act of 1940, Investment
Advisers Act Release No. 3236 (July 12, 2011) [76
FR 41838 (July 15, 2011)] (‘‘2011 Order’’). The 2011
Order was effective as of September 19, 2011. Id.
The 2011 Order applies to contractual relationships
entered into on or after the effective date and does
not apply retroactively to contractual relationships
previously in existence.
15 See May 2011 Release, supra note 13.
16 See Investment Adviser Performance
Compensation, Investment Advisers Act Release
No. 3372 (Feb. 15, 2012) [77 FR 10358 (Feb. 22,
2012)].
17 See rule 205–3(d)(1)(i) and (ii).
18 See rule 205–3(e).
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(‘‘PCE Index’’), which is published by
the United States Department of
Commerce.19 The PCE Index is an
indicator of inflation in the personal
sector of the U.S. economy 20 and is
used in other provisions of the federal
securities laws, including the
determination of whether a person
meets a specific net worth minimum in
Regulation R under the Securities
Exchange Act of 1934 [15 U.S.C. 78a].21
II. Discussion
A. Order Adjusting Dollar Amount Tests
Pursuant to section 418 of the DoddFrank Act and rule 205–3(e), today we
are providing notice 22 that the
Commission intends to issue an order
making the required inflation
adjustment to the assets-undermanagement test and the net worth test
in the definition of ‘‘qualified client’’ in
rule 205–3. As discussed above, section
418 of the Dodd-Frank Act and rule
205–3(e) require that we adjust the
dollar amount thresholds of the rule by
order on or about May 1, 2016 and every
five years thereafter.23 We intend to
issue an order that would maintain the
dollar amount of the assets-undermanagement test at $1,000,000, and
would increase the dollar amount of the
net worth test from $2,000,000 to
19 See
rule 205–3(e)(1).
e.g., Jo Craven McGinty, CPI vs. PCE:
Untangling the Alphabet Soup of Inflation Gauges,
The Wall Street Journal (Mar. 20, 2015), available
at https://www.wsj.com/articles/cpi-vs-pceuntangling-the-alphabet-soup-of-inflation-gauges1426867398; Clinton P. McCully, Brian C. Moyer,
and Kenneth J. Stewart, ‘‘Comparing the Consumer
Price Index and the Personal Consumption
Expenditures Price Index,’’ Survey of Current
Business (Nov. 2007) at 26 n.1 (PCE Index measures
changes in ‘‘prices paid for goods and services by
the personal sector in the U.S. national income and
product accounts’’ and is primarily used for
macroeconomic analysis and forecasting).
21 See Definitions of Terms and Exemptions
Relating to the ‘‘Broker’’ Exceptions for Banks,
Securities Exchange Act Release No. 56501 (Sept.
24, 2007) [72 FR 56514 (Oct. 3, 2007)] (adopting
periodic inflation adjustments to the fixed-dollar
thresholds for both ‘‘institutional customers’’ and
‘‘high net worth customers’’ under Rule 701 of
Regulation R); see also Amendments to Form ADV,
Investment Advisers Act Release No. 3060 (July 28,
2010) [75 FR 49234 (Aug. 12, 2010)] (increasing for
inflation the threshold amount for prepayment of
advisory fees that triggers an adviser’s duty to
provide clients with an audited balance sheet and
the dollar threshold triggering the exception to the
delivery of brochures to advisory clients receiving
only impersonal advice).
The Dodd-Frank Act also requires the use of the
PCE Index to calculate inflation adjustments for the
cash limit protection of each investor under the
Securities Investor Protection Act of 1970. See
section 929H(a) of the Dodd-Frank Act.
22 See section 211(c) of the Advisers Act
(requiring the Commission to provide appropriate
notice of and opportunity for hearing for orders
issued under the Advisers Act).
23 See supra notes 12 and 18 and accompanying
text.
20 See,
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$2,100,000. As required under rule 205–
3, both dollar amounts would take into
account the effects of inflation by
reference to historic and current levels
of the PCE Index. While the dollar
amount of the assets-under-management
test would not change, because the
amount of the Commission’s inflation
adjustment calculation is smaller than
the rounding amount specified under
rule 205–3, the dollar amount of the net
worth test would be adjusted as a result
of the Commission’s inflation
adjustment calculation effected
pursuant to the rule.24
We anticipate that future changes to
the dollar amount tests that are issued
by order will be reflected in technical
amendments to rule 205–3(d), which
would be adopted after such order is
issued.25
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B. Effective Date
We anticipate that, if we issue the
order described above, the effective date
will be 60 days following the order
date.26 To the extent that contractual
relationships are entered into prior to
the order’s effective date, the dollar
amount test adjustments in the order
24 Specifically, rule 205–3(e) provides that the
adjusted dollar amounts shall be computed by: (1)
Dividing the year-end value of the PCE Index (or
any successor index thereto) for the calendar year
preceding the calendar year in which the order is
being issued (in this case, 2015), by the year-end
value of the PCE Index (or successor) for the
calendar year 1997 (such quotient, the ‘‘Adjustment
Percentage’’); (2) for the assets-under-management
test, multiplying $750,000 by the Adjustment
Percentage and rounding the product to the nearest
multiple of $100,000; and (3) for the net worth test,
multiplying $1,500,000 by the Adjustment
Percentage and rounding the product to the nearest
multiple of $100,000.As of April 8, 2016, the endof-year 2015 PCE Index was 109.819, and the endof-year 1997 PCE Index was 79.657. Assets-undermanagement test calculation to adjust for the effects
of inflation: (109.819/79.657) × $750,000 =
$1,033,986.34; $1,033,986.34 rounded to the nearest
multiple of $100,000 = $1,000,000. Net worth test
calculation to adjust for the effects of inflation:
(109.819/79.657) × $1,500,000 = $2,067,972.68;
$2,067,972.68 rounded to the nearest multiple of
$100,000 = $2,100,000.The values of the PCE Index
are available from the Bureau of Economic
Analysis, a bureau of the United States Department
of Commerce. See https://www.bea.gov; see also
Bureau of Economic Analysis, Table 2.3.4., ‘‘Price
Indexes for Personal Consumption Expenditures by
Major Type of Product,’’ available at https://www.
bea.gov/iTable/iTable.cfm?ReqID=9&step=1#
reqid=9&step=1&isuri=1&903=64 (last visited April
8, 2016).
25 See May 2011 Release, supra note 13, at n.27
(noting that the Commission anticipated, when it
issued its notice of intent to issue an order revising
the dollar amount thresholds of the assets-undermanagement test and the net worth test, that ‘‘future
changes to the dollar amount test that are issued by
order, will be reflected in technical amendments to
rule 205–3’’).
26 When the Commission issued the 2011 Order
adjusting the dollar amount tests of rule 205–3 as
described above, the 2011 Order’s effective date was
approximately 60 days following its issuance. See
supra note 14.
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[FR Doc. 2016–12167 Filed 5–23–16; 8:45 am]
Bohnhoff, 935 Pennsylvania Ave. NW.,
Room WB–460, Washington, DC 20535
or by facsimile to 202–436–7248.
FOR FURTHER INFORMATION CONTACT:
Scott Bohnhoff, FBI Occupational Safety
and Environmental Programs (OSEP)
Unit Chief; Email: Scott.Bohnhoff@
ic.fbi.gov; Telephone: (202) 436–7500.
SUPPLEMENTARY INFORMATION:
BILLING CODE 8011–01–P
Electronic Access and Filing
would not generally apply retroactively
to such contractual relationships,
subject to the transition rules
incorporated in rule 205–3.27
By the Commission.
Dated: May 18, 2016.
Brent J. Fields,
Secretary.
DEPARTMENT OF JUSTICE
Federal Bureau of Investigation
28 CFR Part 61
RIN 1110–AA32
National Environmental Policy Act
Procedures
Federal Bureau of
Investigation, Department of Justice.
ACTION: Notice of proposed rule; request
for public comment.
AGENCY:
The Department of Justice is
proposing to promulgate regulations
establishing the Federal Bureau of
Investigation’s (FBI’s) National
Environmental Policy Act (NEPA)
procedures. These proposed regulations
would establish a process for the FBI’s
implementation of NEPA, Executive
Order 11514, Executive Order 12114,
and Council on Environmental Quality
(CEQ) and Department of Justice
(Department) regulations addressing the
procedural provisions of NEPA.
Pursuant to CEQ regulations, the FBI is
soliciting comments on the proposed
FBI NEPA regulations from members of
the interested public.
DATES: Written comments must be
postmarked and electronic comments
must be submitted on or before July 25,
2016. Commenters should be aware that
the electronic Federal Docket
Management System will not accept
comments after 11:59 p.m. Eastern Time
on the last day of the comment period.
ADDRESSES: Submit comments online at
https://www.regulations.gov. Submit
written comments by addressing them
to FBI NEPA Comments, ATTN: Scott A.
SUMMARY:
27 See rule 205–3(c)(1) (‘‘If a registered investment
adviser entered into a contract and satisfied the
conditions of this section that were in effect when
the contract was entered into, the adviser will be
considered to satisfy the conditions of this section;
Provided, however, that if a natural person or
company who was not a party to the contract
becomes a party (including an equity owner of a
private investment company advised by the
adviser), the conditions of this section in effect at
that time will apply with regard to that person or
company.’’); see also May 2011 Release, supra note
13, at section II.B.3.
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Electronic comments are preferred.
For comments sent via U.S. Postal
Service, please do not submit duplicate
electronic or facsimile comments. Please
confine comments to the proposed rule.
All submissions received must
include the agency name (FBI) and
docket number or RIN for this Federal
Register document. The general policy
for comments and other submissions
from members of the public is to make
these submissions available for public
viewing on the Internet at https://
www.regulations.gov as they are
received without change, including any
personal identifiers or contact
information.
Explanation of Proposed Rule
CEQ’s NEPA implementing
regulations contained in 40 CFR parts
1500 through 1508 require each Federal
agency to adopt procedures (40 CFR
1507.3) to ensure that decisions are
made in accordance with the policies
and purposes of NEPA (40 CFR 1505.1).
The Department has established such
policies and procedures at 28 CFR part
61. The FBI NEPA Program has been
established to supplement the
Department’s procedures and to ensure
that environmental considerations are
fully integrated into the FBI’s mission
activities.
The FBI NEPA regulations are
intended to promote reduction of
paperwork by providing guidelines for
development of streamlined and
focused NEPA documents and to reduce
delay by integrating the NEPA process
into the early stages of planning. They
are also intended to promote
transparency by ensuring that NEPA
documents are written in plain language
and follow a clear format so that they
are easily understood by the public and
all parties involved in implementation
of the proposed action.
The FBI NEPA regulations are not
intended to serve as a comprehensive
NEPA guide, but will serve as a
framework for the FBI NEPA Program.
The FBI plans to apply its NEPA
regulations in conjunction with NEPA,
the CEQ regulations (40 CFR parts 1500
through 1508), the Department’s
implementing regulations (28 CFR part
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]]>Agencies
[Federal Register Volume 81, Number 100 (Tuesday, May 24, 2016)]
[Proposed Rules]
[Pages 32686-32688]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-12167]
=======================================================================
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 275
[Release No. IA-4388; File No. S7-08-16]
Performance-Based Investment Advisory Fees
AGENCY: Securities and Exchange Commission.
ACTION: Notice of intent to issue order.
-----------------------------------------------------------------------
SUMMARY: The Securities and Exchange Commission (``Commission'')
intends to issue an order that would adjust for inflation, as
appropriate, dollar amount thresholds in the rule under the Investment
Advisers Act of 1940 that permits investment advisers to charge
performance-based fees to ``qualified clients.'' Under that rule, an
investment adviser may charge performance-based fees if a ``qualified
client'' has a certain minimum net worth or minimum dollar amount of
assets under the management of the adviser. The Commission's order
would increase, to reflect inflation, the minimum net worth that a
``qualified client'' must have under the rule. The order would not
increase the minimum dollar amount of assets under management.
DATES: Hearing or Notification of Hearing: An order adjusting the
dollar amount tests specified in the definition of ``qualified client''
will be issued unless the Commission orders a hearing. Interested
persons may request a hearing by writing to the Commission's Secretary.
Hearing requests should be received by the Commission's Office of the
Secretary by 5:30 p.m. on June 13, 2016. Hearing requests should state
the nature of the writer's interest, the reason for the request, and
the issues contested. Persons who wish to be notified of a hearing may
request notification by writing to the Commission's Secretary.
ADDRESSES: Secretary, Securities and Exchange Commission, 100 F Street
NE., Washington, DC 20549-1090.
FOR FURTHER INFORMATION CONTACT: Amanda Hollander Wagner, Senior
Counsel, Investment Company Rulemaking Office, at (202) 551-6792,
Division of Investment Management, Securities and Exchange Commission,
100 F Street NE., Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission intends to issue an order
under the Investment Advisers Act of 1940 (``Advisers Act'' or
``Act'').\1\
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\1\ 15 U.S.C. 80b. Unless otherwise noted, all references to
statutory sections are to the Investment Advisers Act, and all
references to rules under the Investment Advisers Act, including
rule 205-3, are to Title 17, Part 275 of the Code of Federal
Regulations [17 CFR 275].
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I. Background
Section 205(a)(1) of the Advisers Act generally prohibits an
investment adviser from entering into, extending, renewing, or
performing any investment advisory contract that provides for
compensation to the adviser based on a share of capital gains on, or
capital appreciation of, the funds of a client.\2\ Congress prohibited
these compensation arrangements (also known as performance compensation
or performance fees) in 1940 to protect advisory clients from
arrangements that Congress believed might encourage advisers to take
undue risks with client funds to increase advisory fees.\3\ In 1970,
Congress provided an exception from the prohibition for advisory
contracts relating to the investment of assets in excess of
$1,000,000,\4\ if an appropriate ``fulcrum fee'' is used.\5\ Congress
subsequently authorized the Commission to exempt, by rule or order, any
advisory contract from the performance fee prohibition if the contract
is with persons who the
[[Page 32687]]
Commission determines do not need the protections of that
prohibition.\6\
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\2\ 15 U.S.C. 80b-5(a)(1).
\3\ H.R. Rep. No. 2639, 76th Cong., 3d Sess. 29 (1940).
Performance fees were characterized as ``heads I win, tails you
lose'' arrangements in which the adviser had everything to gain if
successful and little, if anything, to lose if not. S. Rep No. 1775,
76th Cong., 3d Sess. 22 (1940).
\4\ 15 U.S.C. 80b-5(b)(2). Trusts, governmental plans,
collective trust funds, and separate accounts referred to in section
3(c)(11) of the Investment Company Act of 1940 (``Investment Company
Act'') [15 U.S.C. 80a-3(c)(11)] are not eligible for this exception
from the performance fee prohibition under section 205(b)(2)(B) of
the Advisers Act.
\5\ 15 U.S.C. 80b-5(b). A fulcrum fee generally involves
averaging the adviser's fee over a specified period and increasing
or decreasing the fee proportionately with the investment
performance of the company or fund in relation to the investment
record of an appropriate index of securities prices. See rule 205-2
under the Advisers Act; Adoption of Rule 205-2 under the Investment
Advisers Act of 1940, As Amended, Definition of ``Specified Period''
Over Which Asset Value of Company or Fund Under Management is
Averaged, Investment Advisers Act Release No. 347 (Nov. 10, 1972)
[37 FR 24895 (Nov. 23, 1972)].
In 1980, Congress added another exception to the prohibition
against charging performance fees, for contracts involving business
development companies under certain conditions. See section
205(b)(3) of the Advisers Act.
\6\ Section 205(e) of the Advisers Act. Section 205(e) of the
Advisers Act authorizes the Commission to exempt conditionally or
unconditionally from the performance fee prohibition advisory
contracts with persons who the Commission determines do not need its
protections. Section 205(e) provides that the Commission may
determine that persons do not need the protections of section
205(a)(1) on the basis of such factors as ``financial
sophistication, net worth, knowledge of and experience in financial
matters, amount of assets under management, relationship with a
registered investment adviser, and such other factors as the
Commission determines are consistent with [section 205].''
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The Commission adopted rule 205-3 in 1985 to exempt an investment
adviser from the prohibition against charging a client performance fees
in certain circumstances.\7\ The rule, when adopted, allowed an adviser
to charge performance fees if the client had at least $500,000 under
management with the adviser immediately after entering into the
advisory contract (``assets-under-management test'') or if the adviser
reasonably believed, immediately prior to entering into the advisory
contract, that the client had a net worth of more than $1,000,000 at
the time the contract was entered into (``net worth test''). The
Commission stated that these standards would limit the availability of
the exemption to clients who are financially experienced and able to
bear the risks of performance fee arrangements.\8\ In 1998, the
Commission amended rule 205-3 to, among other things, change the dollar
amounts of the assets-under-management test and net worth test to
adjust for the effects of inflation since 1985.\9\ The Commission
revised the former from $500,000 to $750,000, and the latter from
$1,000,000 to $1,500,000.\10\
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\7\ Exemption To Allow Registered Investment Advisers To Charge
Fees Based Upon a Share of Capital Gains Upon or Capital
Appreciation of a Client's Account, Investment Advisers Act Release
No. 996 (Nov. 14, 1985) [50 FR 48556 (Nov. 26, 1985)] (``1985
Adopting Release''). The exemption applies to the entrance into,
performance, renewal, and extension of advisory contracts. See rule
205-3(a).
\8\ See 1985 Adopting Release, supra note 7, at Sections I.C and
II.B. The rule also imposed other conditions, including specific
disclosure requirements and restrictions on calculation of
performance fees. See id. at Sections II.C-E.
\9\ See Exemption To Allow Investment Advisers To Charge Fees
Based Upon a Share of Capital Gains Upon or Capital Appreciation of
a Client's Account, Investment Advisers Act Release No. 1731 (July
15, 1998) [63 FR 39022 (July 21, 1998)].
\10\ See id. at Section II.B.1.
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The Dodd-Frank Wall Street Reform and Consumer Protection Act
(``Dodd-Frank Act'') \11\ amended section 205(e) of the Advisers Act to
provide that, by July 21, 2011 and every five years thereafter, the
Commission shall adjust for inflation the dollar amount thresholds
included in rules issued under section 205(e), rounded to the nearest
$100,000.\12\ In May 2011, the Commission published a release (the
``May 2011 Release'') that included a notice of intent to issue an
order revising the dollar amount thresholds of the assets-under-
management test (from $750,000 to $1,000,000) and the net worth test
(from $1,500,000 to $2,000,000).\13\ The Commission issued an order to
revise the dollar amount thresholds of the assets-under-management and
net worth tests, as described above, on July 12, 2011.\14\
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\11\ Public Law 111-203, 124 Stat. 1376 (2010).
\12\ See section 418 of the Dodd-Frank Act (requiring the
Commission to issue an order every five years revising dollar amount
thresholds in a rule that exempts a person or transaction from
section 205(a)(1) of the Advisers Act if the dollar amount threshold
was a factor in the Commission's determination that the persons do
not need the protections of that section).
\13\ See Investment Adviser Performance Compensation, Investment
Advisers Act Release No. 3198 (May 10, 2011) [76 FR 27959 (May 13,
2011)].
\14\ See Order Approving Adjustment for Inflation of the Dollar
Amount Tests in Rule 205-3 under the Investment Advisers Act of
1940, Investment Advisers Act Release No. 3236 (July 12, 2011) [76
FR 41838 (July 15, 2011)] (``2011 Order''). The 2011 Order was
effective as of September 19, 2011. Id. The 2011 Order applies to
contractual relationships entered into on or after the effective
date and does not apply retroactively to contractual relationships
previously in existence.
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The May 2011 Release also proposed amendments to rule 205-3
providing, among other things, that the Commission would issue an order
every five years in the future adjusting the rule's dollar amount
thresholds for inflation.\15\ On February 15, 2012, the Commission
adopted these proposed amendments, which amended rule 205-3 in three
ways to carry out the inflation adjustment of the rule's dollar amount
thresholds.\16\ First, the amendments revised the dollar amount
thresholds in rule 205-3, in order to codify the order the Commission
issued on July 12, 2011.\17\ Second, the amendments added to rule 205-
3, as proposed, a new paragraph stating that the Commission will issue
an order on or about May 1, 2016, and approximately every five years
thereafter, adjusting for inflation the dollar amount thresholds of the
rule's assets-under-management and net worth tests.\18\ Finally, the
amendments to rule 205-3 specify the price index on which future
inflation adjustments will be based--the Personal Consumption
Expenditures Chain-Type Price Index (``PCE Index''), which is published
by the United States Department of Commerce.\19\ The PCE Index is an
indicator of inflation in the personal sector of the U.S. economy \20\
and is used in other provisions of the federal securities laws,
including the determination of whether a person meets a specific net
worth minimum in Regulation R under the Securities Exchange Act of 1934
[15 U.S.C. 78a].\21\
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\15\ See May 2011 Release, supra note 13.
\16\ See Investment Adviser Performance Compensation, Investment
Advisers Act Release No. 3372 (Feb. 15, 2012) [77 FR 10358 (Feb. 22,
2012)].
\17\ See rule 205-3(d)(1)(i) and (ii).
\18\ See rule 205-3(e).
\19\ See rule 205-3(e)(1).
\20\ See, e.g., Jo Craven McGinty, CPI vs. PCE: Untangling the
Alphabet Soup of Inflation Gauges, The Wall Street Journal (Mar. 20,
2015), available at https://www.wsj.com/articles/cpi-vs-pce-untangling-the-alphabet-soup-of-inflation-gauges-1426867398; Clinton
P. McCully, Brian C. Moyer, and Kenneth J. Stewart, ``Comparing the
Consumer Price Index and the Personal Consumption Expenditures Price
Index,'' Survey of Current Business (Nov. 2007) at 26 n.1 (PCE Index
measures changes in ``prices paid for goods and services by the
personal sector in the U.S. national income and product accounts''
and is primarily used for macroeconomic analysis and forecasting).
\21\ See Definitions of Terms and Exemptions Relating to the
``Broker'' Exceptions for Banks, Securities Exchange Act Release No.
56501 (Sept. 24, 2007) [72 FR 56514 (Oct. 3, 2007)] (adopting
periodic inflation adjustments to the fixed-dollar thresholds for
both ``institutional customers'' and ``high net worth customers''
under Rule 701 of Regulation R); see also Amendments to Form ADV,
Investment Advisers Act Release No. 3060 (July 28, 2010) [75 FR
49234 (Aug. 12, 2010)] (increasing for inflation the threshold
amount for prepayment of advisory fees that triggers an adviser's
duty to provide clients with an audited balance sheet and the dollar
threshold triggering the exception to the delivery of brochures to
advisory clients receiving only impersonal advice).
The Dodd-Frank Act also requires the use of the PCE Index to
calculate inflation adjustments for the cash limit protection of
each investor under the Securities Investor Protection Act of 1970.
See section 929H(a) of the Dodd-Frank Act.
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II. Discussion
A. Order Adjusting Dollar Amount Tests
Pursuant to section 418 of the Dodd-Frank Act and rule 205-3(e),
today we are providing notice \22\ that the Commission intends to issue
an order making the required inflation adjustment to the assets-under-
management test and the net worth test in the definition of ``qualified
client'' in rule 205-3. As discussed above, section 418 of the Dodd-
Frank Act and rule 205-3(e) require that we adjust the dollar amount
thresholds of the rule by order on or about May 1, 2016 and every five
years thereafter.\23\ We intend to issue an order that would maintain
the dollar amount of the assets-under-management test at $1,000,000,
and would increase the dollar amount of the net worth test from
$2,000,000 to
[[Page 32688]]
$2,100,000. As required under rule 205-3, both dollar amounts would
take into account the effects of inflation by reference to historic and
current levels of the PCE Index. While the dollar amount of the assets-
under-management test would not change, because the amount of the
Commission's inflation adjustment calculation is smaller than the
rounding amount specified under rule 205-3, the dollar amount of the
net worth test would be adjusted as a result of the Commission's
inflation adjustment calculation effected pursuant to the rule.\24\
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\22\ See section 211(c) of the Advisers Act (requiring the
Commission to provide appropriate notice of and opportunity for
hearing for orders issued under the Advisers Act).
\23\ See supra notes 12 and 18 and accompanying text.
\24\ Specifically, rule 205-3(e) provides that the adjusted
dollar amounts shall be computed by: (1) Dividing the year-end value
of the PCE Index (or any successor index thereto) for the calendar
year preceding the calendar year in which the order is being issued
(in this case, 2015), by the year-end value of the PCE Index (or
successor) for the calendar year 1997 (such quotient, the
``Adjustment Percentage''); (2) for the assets-under-management
test, multiplying $750,000 by the Adjustment Percentage and rounding
the product to the nearest multiple of $100,000; and (3) for the net
worth test, multiplying $1,500,000 by the Adjustment Percentage and
rounding the product to the nearest multiple of $100,000.As of April
8, 2016, the end-of-year 2015 PCE Index was 109.819, and the end-of-
year 1997 PCE Index was 79.657. Assets-under-management test
calculation to adjust for the effects of inflation: (109.819/79.657)
x $750,000 = $1,033,986.34; $1,033,986.34 rounded to the nearest
multiple of $100,000 = $1,000,000. Net worth test calculation to
adjust for the effects of inflation: (109.819/79.657) x $1,500,000 =
$2,067,972.68; $2,067,972.68 rounded to the nearest multiple of
$100,000 = $2,100,000.The values of the PCE Index are available from
the Bureau of Economic Analysis, a bureau of the United States
Department of Commerce. See https://www.bea.gov; see also Bureau of
Economic Analysis, Table 2.3.4., ``Price Indexes for Personal
Consumption Expenditures by Major Type of Product,'' available at
https://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1#reqid=9&step=1&isuri=1&903=64 (last
visited April 8, 2016).
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We anticipate that future changes to the dollar amount tests that
are issued by order will be reflected in technical amendments to rule
205-3(d), which would be adopted after such order is issued.\25\
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\25\ See May 2011 Release, supra note 13, at n.27 (noting that
the Commission anticipated, when it issued its notice of intent to
issue an order revising the dollar amount thresholds of the assets-
under-management test and the net worth test, that ``future changes
to the dollar amount test that are issued by order, will be
reflected in technical amendments to rule 205-3'').
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B. Effective Date
We anticipate that, if we issue the order described above, the
effective date will be 60 days following the order date.\26\ To the
extent that contractual relationships are entered into prior to the
order's effective date, the dollar amount test adjustments in the order
would not generally apply retroactively to such contractual
relationships, subject to the transition rules incorporated in rule
205-3.\27\
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\26\ When the Commission issued the 2011 Order adjusting the
dollar amount tests of rule 205-3 as described above, the 2011
Order's effective date was approximately 60 days following its
issuance. See supra note 14.
\27\ See rule 205-3(c)(1) (``If a registered investment adviser
entered into a contract and satisfied the conditions of this section
that were in effect when the contract was entered into, the adviser
will be considered to satisfy the conditions of this section;
Provided, however, that if a natural person or company who was not a
party to the contract becomes a party (including an equity owner of
a private investment company advised by the adviser), the conditions
of this section in effect at that time will apply with regard to
that person or company.''); see also May 2011 Release, supra note
13, at section II.B.3.
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By the Commission.
Dated: May 18, 2016.
Brent J. Fields,
Secretary.
[FR Doc. 2016-12167 Filed 5-23-16; 8:45 am]
BILLING CODE 8011-01-P
