"Family offices" are entities established by wealthy families to manage their wealth, plan for their families' financial future, and provide other services to family members. It is estimated that there are between 2,500 and 3,000 single family offices in the United States managing more than $1.2 trillion in assets. Generally, family offices meet the definition of "investment adviser" under the Investment Advisers Act of 1940 (the Advisers Act) because, among other things, they are in the business of providing advice about securities for compensation. However, family offices usually either take advantage of the private adviser exemption found in Section 203(b) of the Advisers Act1 or request an exemptive order from the U.S. Securities and Exchange Commission (the SEC) declaring the office not to be an investment adviser.
The Dodd-Frank Act2 amended the Advisers Act to exclude a family office from the definition of "investment adviser;" however, it directed the SEC to adopt a definition of family office. The incorporation of a definition of family office into the Advisers Act is necessary because the Dodd-Frank Act will rescind the private adviser exemption effective July 21, 2011. Thus, without the new definition of family office, the majority of family offices in the United States would have to register with the SEC as investment advisers, and would be subject to the Advisers Act.
On October 12, 2010 the SEC issued a release proposing a definition of family office.3 The definition, which, if adopted, would appear in new Rule 202(a)(11)(G)-1 of the Advisers Act, and largely codify the exemptive orders that the SEC has issued to family offices.
Three Conditions of a Family Office
The proposed rule contains three general conditions, which pertain to (1) the office's types of clients, (2) its ownership and control and (3) how it holds itself out to the public.
- Clients
As proposed, a family office is not permitted to have any investment advisory clients other than "family clients." Family clients would include family members, certain key employees of the family office, charities established and funded exclusively by family members or former family members, trusts or estates existing for the sole benefit of family clients, and entities wholly owned and controlled exclusively by, and operated for the sole benefit of, family clients, and under certain circumstances, former family members or former employees.4 For purposes of the definition of family office, the terms "family members," "key employees" and "control" would have the following meanings:
- Family Members – the individual and his or her spouse or spousal equivalent for whose benefit the family office was established and any of their subsequent spouses or spousal equivalents, their parents, their lineal descendants (including by adoption and stepchildren), and such lineal descendants' spouses or spousal equivalents.
- Key Employees – any natural person (including persons who hold joint and community property with their spouse) who is (i) an executive officer, director, trustee, general partner, or person serving a similar capacity of the family office, or (ii) any other employee of the family office (other than an employee performing solely clerical, secretarial, or administrative functions) who, in connection with his or her regular duties, has participated in the investment activities of the family office, or similar functions or duties for or on behalf of another company, for at least 12 months.
- Control
– the power to exercise a controlling influence over the
management or policies of a company, unless such power is solely
the result of being an officer of such company.
- Ownership and Control
To fall within the proposed definition, a family office would have to be wholly owned and controlled, either directly or indirectly, by family members. This will distinguish family offices from family "run" offices. - Holding Out
The final condition of the proposed definition of a family office is that a family office may not hold itself out to the public as an investment adviser.
Grandfathering Provisions
Pursuant to the Dodd-Frank Act, the proposed definition of family office contains a "grandfathering clause" that prohibits the SEC from excluding certain family offices from the definition of family office solely because they provided investment advice to certain clients prior to January 1, 2010. The grandfathered clients are (i) natural persons who, at the time of their investment, (a) were officers, directors, or employees of the family office, (b) were accredited investors under Regulation D of the Securities Act of 1933, and (c) had invested with the family office before January 1, 2010; and (ii) investment advisers registered under the Advisers Act that in turn provide investment advice and identify investment opportunities to the family office and invest in such transactions on substantially the same terms as the family office invests, but do not invest in other funds advised by the family office and whose assets as to which the family office directly or indirectly provides investment advice represent, in the aggregate, not more than 5 percent of the value of the total assets as to which the family office provides investment advice. Clients that are grandfathered into the definition of family office will be subject to the antifraud provisions of the Advisers Act.
The period to comment on the proposed definition of family office ends November 18, 2010.
Footnotes
1 The private adviser exemption applies to any adviser that during the course of the preceding 12 months had fewer than 15 clients and neither held itself out to the public as an investment adviser nor advised any registered investment company or business development company.
2 The Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111-203).
3 SEC Release No. IA-3098 (Oct. 12, 2010).
4 Former family members and former employees would be able to retain investments held through the family office, but would not be allowed to make any new investments or receive investment advice from the family office (except with respect to investments the individual was contractually obligated to make prior to becoming a "former" family member or employee).
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