The Securities and Exchange Commission plans to adjust two tests that registered investment advisors must use to determine if they can charge performance-based fees. The changes would result in about 195,000 households no longer being considered "qualified clients."

Current SEC rule 205-3 under the Investment Advisers Act of 1940 requires that a client must have at least $750,000 under management or a net worth of more than $1.5 million if they are to be charged performance-based fees. The Dodd-Frank Wall Street Reform and Consumer Protection Act requires that by July 21 and every five years thereafter, the SEC adjust for inflation these dollar-amount tests.

The SEC plans to amend the rule by raising the assets-under-management test to $1 million and the net-worth test to $2 million. The revised dollar amounts reflect inflation as of the end of last year. The amendment would specify that the PCE Index will be the inflation index used to calculate future inflation adjustments.

Also, the SEC proposes to adjust the net-worth standard for a "qualified client" to exclude the value of a person's primary residence and debt secured by the property that is no greater than the property's current market value. If the outstanding debt exceeds the market value of the residence, the amount of the excess would be considered a liability in calculating net worth.

"The value of an individual's primary residence may bear little or no relationship to that person's financial experience or ability to bear the risks associated with performance-fee arrangements," the SEC said. "Therefore, a client who does not meet the net worth test of rule 205-3 without including the value of her primary residence would be protected by the performance-fee restrictions in section 205 of the Advisers Act."

The SEC also wants to modify the rule so that the changes would not be retroactive-RIAs would not be required to renegotiate terms of arrangements that were permissible when the parties entered into them.

Based on data from the Federal Reserve Board, approximately 5.5 million households have a net worth of more than $2 million including the equity in the primary residence, and approximately 4.2 million households have a net worth of more than $2 million excluding the equity in the primary residence, the SEC said. Therefore, approximately 1.3 million households currently would not meet a $2 million net worth test under the proposed revisions. As result, those households would not be considered "qualified clients" if the value of the primary residence is excluded from the test and would not not be able to enter performance-fee contracts unless they meet another test of the rule.

The SEC estimates that about 25% of the 1.3 million households, or 325,000, would have entered new advisory contracts after the compliance date of the amendments and would not meet the revised net-worth test. However, SEC staff estimates 40% of those households would separately meet the "qualified client" test because they would meet the AUM test-they'd have $1 million or more to be managed. The remaining 60%, or 195,000 households, still could use advisors who charge advisory fees that are not performance based. The SEC believes only 20% of the 195,000, or 39,000 households, would choose not to invest with any advisor because of the changes.

The SEC is requesting comments on these amendments to rule 205-3 by July 11. Comment can be made by using the SEC's Internet comment form (www.sec.gov/rules/proposed.shtml); by sending e-mail to rule-comments@sec.gov with "File Number S7-17-11" on the subject line; or using the Federal eRulemaking Portal (www.regulations.gov).