Rule 206(4) 2 regulates the custody of client
funds and securities by investment advisers "registered or
required to be registered under" the Advisers Act. A single
family office that complies with Rule 202(a)(11)(G) 1 "shall
not be considered to be an investment adviser for purpose of the
[Advisers] Act" and, therefore, is not subject to Rule 206(4)
Exempt family offices may nevertheless want to consider
following certain aspects of Rule 206(4) 2, such as:
Identifying the family office as
agent or trustee for family office accounts;
Providing periodic account statements
to family members, indicating where their assets are held;
Obtaining an internal control report
to assure there are adequate controls for accessing funds,
securities and other investments; and
If the family office does not produce
audited financials, having an accountant periodically test and
verify holdings in custody accounts and compliance with
Family office employees are less likely to succumb to temptation
if they know the family's assets are independently
Registered Family Offices
The new guidance is aimed at registered investment advisers
(RIAs) who do not have "custody" for purposes of Rule
206(4) 2. According to IM:
Most family offices registered as RIAs cannot limit their
authority to sending trade instructions to the custodian. Family
offices often maintain accounts for paying taxes and other
expenses, managing real property or family businesses and other
non-investment purposes. Even if investment funds are maintained in
segregated accounts, the family office needs to withdraw funds from
these accounts to provide income to family members or to cover
expenditures. Rule 206(4) 2(d)(2)(ii) defines "custody"
Any arrangement ... under which you [the RIA] are authorized or
permitted to withdraw client funds or securities maintained with a
custodian upon your instruction to the custodian[.]
Thus, if a family office registers with the SEC, it will
typically be treated as having custody of the family's funds
and securities and must hold these funds and securities in
compliance with Rule 204(6) 2.
The potential pitfall is that Rule 204(6) 2 applies to all funds
or securities over which a registered family office has custody,
even if they are not involved in the investment management side of
the office. For example, an account used primarily to pay taxes on
behalf of family members would be subject to paragraph (a)(1) of
the rule. See, Piedmont Financial Co., 1990 WL 286501 SEC No-Action
Letter (pub. avail. May 30, 1990). Similarly, interests in an LLC
used by the family office to manage real estate holdings would be
"privately offered securities" subject to paragraph
(b)(2) of the rule.
A family office that is an RIA must therefore take care to
identify all bank and security accounts maintained by the office,
and all business entities established by the office, in response to
the periodic surprise examination required by paragraph (a)(4) of
the rule, even if the accounts or entities have nothing to do with
the office's investment activities. Omission of any accounts or
entities could lead to an inadvertent violation of Rule 204(6)
In a subsequent blog, we will consider whether it is possible
for a large family office to separate its RIA from its other
functions for purposes of Rule 204(6) 2.
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.
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