Trey Baldy is a Partner in our Tampa office
Family Offices
Wealthy families frequently use "family offices" to manage family wealth and provide business services to family members. Family offices may provide wealthy families a convenient way to manage mutual business interests with privacy and limited regulation. Services provided by family offices often include securities portfolio investment management, fiduciary services, and financial, tax and estate planning. Family offices may also offer investment decision advice to family members. Fees may be assessed for these services, but are not required.
Such services are commonly regulated under the Investment Advisers Act of 1940 ("Advisers Act"). A typical commercial investment firm engaged in the business of providing such services likely would be considered an "investment adviser" and thus subject to the Advisers Act's requirement of registration with the Securities and Exchange Commission (SEC), and also subject to the Advisers Act's reporting and other obligations.
Historically, most family offices avoided the Advisers Act's registration, reporting and other obligations by relying on the "private adviser exemption" in Section 203(b)(3) of the Advisers Act. This exempted any investment adviser with less than 15 "clients" provided that the adviser did not hold itself out to the public as an investment adviser. Some family offices alternatively relied on separate SEC administrative exemption orders or rulings. The realm of families that relied on the private adviser exemption was broadened by certain rules under the Advisers Act providing that "pooled investment vehicles" generally qualified as a single client.
The Dodd-Frank Act and SEC Family Office Rule
Effective July 21, 2011, the private adviser exemption was repealed by The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"). The apparent intent was to protect investors in dealings with commercial investment advisers (including hedge funds and private fund advisers), even if the adviser had less than 15 clients, but the consequence was to potentially expose family offices to the burdensome registration and other requirements of the Advisers Act. To address this concern, the Dodd-Frank Act provided for the SEC's adoption of a new "family office rule" (Rule 202(a)(11)(G)-1) that establishes criteria for family offices to be exempt from regulation under the Advisers Act. The SEC's new family office rule became effective August 29, 2011, and can be found at http://www.sec.gov/rules/final/2011/ia-3220.pdf.
There are three basic requirements to qualify for exemption of a family office under the family office rule (Rule 202(a)(11)(G)-1(b)(1)-(3)), as follows:
- The family office may give advice about securities only to
"family clients."
- The term "family clients" is generally defined to include: (1) current and former family members; (2) current and some former key employees; (3) estates of family clients; (4) irrevocable trusts having family clients as sole beneficiaries, or that are funded by family clients and have family clients and charities as sole beneficiaries; (5) revocable trusts funded solely by family clients; and (6) family entities or companies that are wholly owned by and operated for the sole benefit of family clients.
- The term "family members" is generally defined to
include all of the following within 10 generations from a
designated common ancestor: lineal descendants (including adopted
children, stepchildren, foster children and minors under the legal
guardianship of a family member); and current and former spouses
and "spousal equivalents." The common ancestor may be
changed but such change could alter the makeup of the family member
group.
- The family office must be wholly owned by "family clients" and controlled only by "family members" or "family entities."
- The family office must not hold itself out to the public as an investment adviser.
Impact on "Multi Family" Offices
The greatest impact of the new family office rule might be felt by family offices that currently service more than one "family client" but less than 15 total clients. Under the prior private adviser exemption, such offices would have been exempt from the Advisers Act, but under the family office rule, they are limited to a single "family client" and may not serve "multiple families," so they would not qualify for the exemption. (http://www.sec.gov/rules/final/2011/ia-3220.pdf; Section 4, p. 33)
Pre-existing Exemption Orders
Before the Dodd-Frank Act became law, the SEC previously had issued case-specific exemption orders to a few family offices. The new family office rule does not terminate those orders, and any existing family office that was the recipient of such an order may continue to do so.
Impact
Pursuant to the Dodd-Frank Act, a family office must comply with every aspect of the family office rule exemption requirements in order to avoid the Advisers Act registration and other requirements. Thus, for example, if a family office has clients that are outside of the permitted "family client" group, the office will not be eligible for the exemption. While the definition of "family client" is fairly broad, even including some key employees, former spouses and "spousal equivalents," the family office must stay vigilant to ensure its services do not exceed the specific defined categories of permitted parties. Also, while the exemption is "self executing" in that an SEC filing is not necessary to rely on the exemption, any family office that intends to rely on this exemption should keep well documented records establishing its compliance with the criteria for exemption.
Potential Responses
If a family office does not satisfy the criteria under the family office rule but does not want to undertake the process of Advisers Act compliance, possible alternatives may be:
- Discontinue providing "investment advice." Note that the Advisers Act applies to the provision of investment advice, but family offices can continue to provide family members other kinds of business and administrative services. This may be easier said than done, however, as the definition of "investment advice" is very broad.
- Restructure the family office to exclude parties that do not fall within the definition of "family clients."
- Seek an administrative exemptive relief order from the SEC.
- Retain an outside third-party investment adviser that is in compliance with the Advisers Act.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
