SEC Proposes to Significantly Expand Performance Fee Eligibility

On September 30, 2026, the SEC proposed to significantly expand registered investment advisers’ ability to receive performance-based compensation.¹ The proposal would, among other things, provide a new path for regulated funds (including registered open-end funds, registered closed-end funds and BDCs) to pay performance fees on capital gains or appreciation. It would also permit performance fees to be charged to “accredited investors” by including such status within the “qualified client” definition.

The SEC’s performance fee proposal comes as part of its efforts to expand retail investor access to private market strategies and was proposed concurrently with proposed amendments to modernize, enhance and simplify the interval fund framework. For more information on the interval fund proposal, please see our companion OnPoint, SEC Proposes Interval Fund Updates, Extension of Multi-Class Relief for Closed-End Funds and BDCs.

Investment Adviser Performance-Based Compensation Modernization Proposal

The SEC has proposed amendments to Advisers Act Rule 205-3, the exemptive rule from the statutory ban on investment advisers charging fees based on a share of capital gains or capital appreciation.

The proposal would (1) allow advisers to charge such performance-based compensation to registered open-end funds (including mutual funds and ETFs), registered closed-end funds (including interval funds, tender offer funds, and listed funds) and BDCs (collectively “regulated funds”), subject to conditions, and (2) expand eligibility for performance fees generally by including “accredited investors” (as defined under Regulation D) within the “qualified client” definition, while removing the existing standalone net worth and assets-under-management tests.

Comments are due 60 days after Federal Register publication (exact date not yet set).

Key proposed changes

• The Proposal provides a new path for all regulated funds to pay performance fees on capital gains or capital appreciation, subject to three conditions: (i) the fee cannot exceed 20% of the fund’s net gains or net capital appreciation over a specified period or as of definite dates; (ii) the fund must satisfy the fund governance standards under Rule 0-1(a)(7) (i.e., independent-director majority, independent nomination and counsel, annual board self-evaluation, and quarterly independent-director sessions with authority to retain staff and advisers); and (iii) the fund’s board, including a majority of independent directors, must, as part of the fund’s annual review and approval of the advisory contract under Section 15(c) of the 1940 Act, determine that the performance compensation arrangement is in the best interest of the fund and shareholders, with specific written findings on its appropriateness, basis of calculation and investor protection features.
• This would apply to all regulated funds, including open-end funds (e.g., mutual funds/ETFs), closed-end funds and BDCs (listed and unlisted). The rule is not limited to closed-end funds and BDCs traditionally associated with private-market strategies.
• Unlike the current BDC-only statutory exception (which permits fees only on realized gains), the proposal would permit advisers to regulated funds to charge performance fees on both realized and unrealized net capital gains or net capital appreciation.
• Broadened “qualified client” definition: The proposal would retain the general approach of permitting performance-based compensation arrangements with respect to clients that are “qualified clients.” The proposal would add “accredited investor” status as a way to qualify, while removing the existing separate net worth test (currently set at $2.7 million net worth) and the assets-under-management test (currently set at $1.4 million) from the qualified client definition. This would improve access to investment products with performance fees for accredited investors and simplify the application of the qualified client standard by making it unnecessary for advisers to funds that already restrict investors to accredited investors (e.g., section 3(c)(1) private funds relying on Regulation D) to screen investors under a separate qualified-client standard. Advisers would continue to be permitted to regulate the sophistication of their investor group through minimum investment requirements and other restrictions.
• Modifications to look-through for 3(c)(1) funds and regulated funds:
  • Under current Rule 205-3, in the case of section 3(c)(1) private funds and regulated funds, each equity owner (except the adviser and other equity owners not charged a performance fee) is considered a client for purposes of the rule. Thus, advisers must “look through” to such equity owners to confirm each is a “qualified client” in order to charge performance fees to section 3(c)(1) private funds or registered funds in reliance on current Rule 205-3.
  • Under the proposal, a section 3(c)(1) private fund would be a “qualified client” (i.e., could be charged a performance fee under Rule 205-3) if each equity owner itself is a qualified client (except for equity owners not charged a performance fee), similar to the current look-through provision. As noted above, however, the “qualified client” definition is proposed to be broadened to include accredited investors, while removing the existing standalone net worth and assets-under-management tests.
  • A regulated fund would be a “qualified client” (i.e., could be charged a performance fee under Rule 205-3) if either (i) each equity owner of the regulated fund is a “qualified client” (similar to the current look-through provision, though with the broadened qualified client definition), or (ii) the three conditions discussed above are satisfied (20% cap, fund governance standards, board best-interest finding).
• Regulated fund disclosures: Under the proposal, new disclosures would need to be included in the prospectus and periodic reports for regulated funds that adopt performance fees:
  • The fee table would include a line item regarding the performance fee with a footnote describing the basis for the performance fee, cross-referencing other more detailed disclosures on the performance fee and explaining certain features of the performance fee.
  • The expense example would reflect the performance fee.
  • The management discussion would include a detailed description of the performance fee arrangement, including a graphical representation illustrating the calculation of the performance fee across a range of hypothetical performance scenarios.

Practical Takeaways

The SEC frames the performance fee proposal as part of a broader effort to reduce regulatory barriers to product innovation and to let a wider range of investors access performance-fee-based products traditionally confined to private funds. For firms sponsoring or advising regulated funds, this opens up many new fee structure possibilities and may provide new ways to align financial incentives of managers and fund investors. For private funds and investment advisers, the proposal could create meaningful changes to accounts eligible for performance fees.

Firms interested in commenting on the proposal should plan to provide comments before the end of the 60-day deadline.

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