The SEC is giving investment advisers greater latitude in charging certain clients performance or incentive fees, but has also made it tougher for investors to qualify for such treatment.

In July, the agency eliminated all of the contractual and disclosure provisions in amended Rule 205-3 of the Investment Advisers Act other than the client eligibility tests, which it changed.

Kathy Ireland, a staff attorney in the Division of Investment Management at the SEC, says the aim of the change was to provide greater flexibility to both the adviser and the client, as well as increase the thresholds that determine a sophisticated investor to reflect inflation.

If you have a sophisticated client, the client and adviser can determine what terms are best between them, says Ireland. She says the SEC relieved many of the contractual obligations between the client and the adviser, but still holds the adviser to making fair disclosures as a fiduciary.

Im kind of surprised they did this, says Nancy Lininger, president of The Consortium, a regulatory consulting company based in Camarillo, Calif. They say that they havent seen abuses in performance fees dealing with sophisticated investors, and my feeling is that that may be because the rules are working.

Performance or incentive fees are most common in private investment partnerships where advisers receive higher compensation based on their investment performance. For example, an adviser might receive 2% on assets under management and a performance fee of 20% of the net profits on the account if the investment return exceeded 30% on an annualized basis.

The SEC says that the elimination of the disclosure provisions doesnt alter the obligation of an adviser, as a fiduciary, to deal fairly with clients, and to make full and fair disclosure of compensation arrangements.

The current rule permits advisers to charge performance fees to clients with at least $500,000 under the advisers management or with a net worth of more than $1 million. The new provisions require a client to have at least $750, 000 under management with the adviser, or a net worth of more than $1.5 million, or be a qualified purchaser as defined in the 40 act.

Jacqueline Hallihan, president of National Regulatory Services in Lakeville, Conn., says its the commissions position that Rule 205-3 may have inhibited the flexibility of advisers and their clients in establishing performance fee arrangements that would be beneficial to both parties. Also, she says the SEC believes that under other protections provided under the 40 act, clients may not need the protection of current Rule 205-3.