Executive Summary
On September 30, 2026, the SEC proposed amendments to Advisers Act Rule 205-3[1] that would permit advisers to mutual funds, ETFs, closed-end funds, and BDCs to charge a broader range of performance fees on both realized and unrealized gains—subject to a 20% cap, heightened board governance and findings, and new disclosure. The amendments also align the “qualified client” standard for private funds and managed accounts with the “accredited investor” definition. The proposals would do the following:
- Broaden performance-fee authority. Registered funds could pay advisers performance-based compensation under a new conditions-based framework and would no longer be limited to a symmetric “fulcrum-fee” or selling only to qualified clients. BDCs—which already may pay an incentive fee of up to 20% of net realized capital gains—could instead pay up to 20% of net gains measured to include unrealized appreciation.
- Shift implementation demands rather than eliminate them. The proposed rule amendments would reduce several prescriptive constraints but would place greater weight on board review, adviser systems, compliance controls, disclosure and documented decision-making.
Performance-Based Compensation Modernization
Proposed changes. The Advisers Act generally prohibits an adviser from being compensated based on a share of a client’s capital gains or capital appreciation. Currently, Rule 205-3 exempts only arrangements with “qualified clients.” Registered funds are otherwise limited to a symmetric “fulcrum fee” and BDCs may charge an incentive fee of up to 20% of net realized capital gains. The SEC would amend Rule 205-3 under the Advisers Act to permit registered investment advisers to receive performance-based compensation from registered funds and BDCs, including mutual funds and ETFs, subject to specified fee limits, governance conditions, and disclosure requirements.
Under the proposal:
- performance-based compensation could not exceed 20% of the fund’s net gains, whether realized or unrealized, over the applicable measurement period or as of specified dates;
- the compensation formula could take account of net realized gains, net unrealized gains or appreciation or both, subject to the proposed conditions;
- the fund would have to satisfy the fund governance standards in Investment Company Act Rule 0-1(a)(7);
- the board, including a majority of independent directors, would have to approve the arrangement and determine that it is in the best interests of the fund and its shareholders;[2] and
- the board would have to make written findings addressing the arrangement’s appropriateness in light of the fund’s strategy and valuation practices; the compensation calculation, measurement period, and treatment of gains; and the adequacy of protections against compensation that does not appropriately reflect shareholder experience.[3]
Board judgment would be central. The release identifies hurdle rates, preferred returns, high-water marks and loss-carryforward mechanisms as possible ways to align adviser compensation with shareholder experience, but it does not mandate any particular feature. The board instead would assess whether the arrangement, considered as a whole, provides adequate protection against compensation that does not appropriately reflect shareholder experience.[4] The SEC asserts that the proposed conditions “create a structured, board-centered governance process through which advisers to regulated funds may access performance-based compensation arrangements in a manner that is consistent with investor protection and the purposes of the Advisers Act.”[5]
Board implications. The proposal would place the performance-fee decision squarely with the board, and in particular its independent directors, as part of the initial approval and annual continuance of the advisory contract under Section 15(c). The release is explicit that the required written findings are not a restatement of the Section 15(c) and Section 36(b) inquiry into whether overall compensation is excessive; they are additional, more particularized findings directed at the design of the performance fee itself. Independent directors would be expected to assess whether the arrangement is consistent with the fund’s strategy and whether the fee could incentivize excessive risk, volatility or shifts in portfolio construction, leverage or concentration inconsistent with the fund’s objectives, particularly around measurement dates; to scrutinize the fund’s valuation practices—an oversight the release characterizes as active rather than passive—with heightened attention where the fee would be calculated on assets lacking readily available market quotations; to evaluate the basis and measurement period of the fee and whether it reaches realized gains, unrealized appreciation or both; and to determine whether investor-protection features adequately guard against compensation that does not reflect shareholder experience.
Enhanced Disclosure Requirements
Expanded disclosure. The proposal would amend the registration forms—Forms N-1A and N-2—to require registered funds to disclose performance-based compensation separately and in a more standardized format. In the prospectus fee table, the definition of “management fees” would be revised to exclude performance fees, and any performance-based compensation would appear as a distinct line item, accompanied by an alert to the variability of such fees, a cross-reference to the fuller discussion and an expense example that reflects the performance fee. The management discussion would have to describe the arrangement using a standardized list of items—the rate and basis of the fee (whether calculated on realized gains, unrealized gains or appreciation, investment income or a combination), whether it is measured before or after fees and expenses, the measurement period and any features that limit or condition payment, such as a preferred return, hurdle rate, high-water mark or loss-carryforward mechanism—and include a graphical representation illustrating the calculation of the performance fee across a range of hypothetical performance scenarios.
Broader reach than the fee amendments. These disclosure requirements would apply more broadly than the amendments to Rule 205-3: They would reach every registered fund that pays a performance fee, including funds that pay symmetric fulcrum fees and fees based on measures other than capital gains, not only funds relying on the new performance fee framework.
Expansion of the Qualified Client Standard
Related investor-eligibility change. The SEC also would incorporate the “accredited-investor” definition into Rule 205-3 and eliminate the rule’s existing assets-under-management and net-worth tests. This change would principally affect unregistered products that charge performance fees—such as Section 3(c)(1) funds and separately managed accounts—rather than registered funds relying on the new performance-fee framework, for which the qualified client gating condition would no longer apply. Because many private offerings already use the accredited-investor standard, the amendment would align the two eligibility frameworks and expand the population able to enter into performance fee arrangements in those unregistered products. For a 3(c)(1) fund, the rule would continue to look through to the fund’s equity owners—treating the fund as a qualified client where each owner is itself a qualified client.
Separate request for comment. In a related action, the SEC requested comment on whether to expand the accredited-investor definition to recognize certain professional credentials—including the CPA, CFA and CFP designations and FINRA Series 79, 86 and 87 licenses—and whether passing a FINRA-administered accredited-investor examination should qualify an individual. This is a request for comment rather than a proposed rule, and any change would require separate rulemaking.
Potential Industry Implications
Why it matters. Registered funds offered to retail investors generally are limited today to symmetric fulcrum fees. The proposal would permit a substantially broader range of performance fee arrangements, subject to the 20% cap, prescribed governance standards, enhanced disclosure, and fund-specific board findings. For BDCs, the principal change would be the ability to calculate the fee using net gains that include unrealized appreciation. Existing funds would need to seek shareholder approval to implement a performance fee or change an existing fulcrum fee. Accordingly, the impact of the change may be limited primarily to new products.
Operational implications. Advisers considering a performance fee would need reliable processes for applying the selected measurement period, tracking realized and unrealized gains or appreciation, allocating compensation consistently and producing the proposed prospectus and periodic-report disclosures. Private fund and separate account advisers also would need to revisit subscription materials and eligibility procedures if they rely on the new qualified client definition.
Next Steps
Comment period. Comments are due on December 7, 2026.
What firms should assess now. Asset managers and boards should consider whether the proposals would affect planned products or existing structures and identify the governance, valuation, disclosure, systems and compliance changes that implementation could require. Firms considering comments may wish to focus on the workability of the proposed board findings, the treatment of unrealized gains and the broadened qualified client standard.
If you have any questions about this article, please contact Debby Eades at deades@vedder.com, Nate Segal at nsegal@vedder.com or any other Vedder attorney with whom you have worked.
1. Investment Adviser Performance-Based Compensation Modernization, Release No. IA-7022 (Sept. 30, 2026) (“Proposing Release”), available here.
2. “The proposed best interest determination reflects the Commission’s view that the board is best positioned to assess whether the specific contours of a proposed compensation arrangement are appropriate for a given regulated fund.” Proposing Release at 52.
3. “Under the proposed best interests finding, a board would need to consider, for example, whether the adviser’s portfolio construction, use of leverage, or concentration of positions has materially shifted in a manner that appears inconsistent with the fund’s investment strategy, particularly during periods proximate to performance fee measurement dates.” Id. at 53.
4. “If no investor protection features are included in the performance-based compensation arrangement, the proposed amendments would require that the board’s determination include written findings that address the basis for concluding that the compensation arrangement is adequate to protect the interests of shareholders without such investor protection features.” Id. at 60.
5. Id.
