On July 21, 2010, President Obama signed into law the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the
"Dodd-Frank Act"). The Dodd-Frank Act, among other
things, will repeal the 15-client exemption contained in Section
203(b)(3) of the Advisers Act, effective July 21, 2011. The primary
purpose of repealing this exemption was to require advisers to
private funds to register under the Advisers Act. However, another
consequence, which Congress recognized, was that many family
offices that have relied on that exemption would be required to
register under the Advisers Act or seek an exemptive order from the
Securities Exchange Commission (the "Commission") before
the law becomes effective.
In order to prevent that consequence, Section 409 of the Dodd-Frank
Act creates a new exclusion from the Advisers Act in Section
202(a)(11)(G), under which family offices, as defined by the
Commission, are not investment advisers subject to the Advisers
Act. While Section 409 instructs that any definition the Commission
adopts should be consistent with the previous exemptive policy, and
recognize "the range of organizational, management, and
employment structures and arrangements employed by family
offices," this bulletin is meant to inform clients of the
manner in which the proposed definition, which is now subject to
public comment, may differ from existing practice.
The proposed rule contains three general conditions:
- It would limit the availability of the rule to family offices that provide advice about securities only to certain family members and key employees.
- It would require that the family members wholly own and control the family office.
- It would preclude a family office from holding itself out to the public as an investment adviser.
Who are Family Clients? Similar to existing practice, this term would include family members, certain employees of the family office, 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 and former employees.
Changes from Existing Practice
The following are all-new concepts in which the Commission has
requested comment from the family office community as to their
appropriateness. In addition, in general, the Commission wishes to
know whether it is drawing the line too broadly or too narrowly
regarding who is a family member and who is not.
Step-Children - The Proposed Rule 202(a)(11)G-1
would include step-children as family members. Step-Children would
be permitted to be included as members of a family office but would
not be required to be included.
Spousal Equivalents – The Proposed Rule
202(a)(11)(G)-1(d)(3) would include "spousal equivalents"
which is defined as a cohabitant occupying a relationship generally
equivalent to that of a spouse.
Parents of the Family Office's Founders
– The Proposed Rule 202(a)(11)(G)-1(d)(3) would include
the parents of the family office's founders in recognition that
these founders may wish to include one or more of their parents as
a client of the family office.
Siblings of the founders of the family office, their spouses or
spousal equivalents, their lineal descendants (including by
adoption and step-children), and such lineal descendants'
spouses or spousal equivalents – See Proposed Rule
202(a)(11)(G)-(1)(d)(3).
Multiple Families - The practice of adding other
families to a family office to achieve economies of scale will not
be permitted under the Proposed Rule. The Commission is concerned
that these multifamily offices more resemble a typical commercial
investment adviser requiring registration under the Advisers
Act.
Involuntary Transfers - The Proposed Rule
202(a)(11)(G)-1(b)(1) would permit the family office to continue to
advise the beneficiary of an involuntary transfer who does not
qualify as a family client for four months following the transfer
of assets resulting from the involuntary event. The four month
period is deemed adequate to allow the family office to orderly
transition that client's assets to another investment adviser,
seek exemptive relief, or register under the Advisers Act.
Former Family Members - The Proposed Rule
202(a)(11)(G)-1(d)(2) (vi) and (d)(4) would for the first time
permit former family members, i.e., former spouses, spousal
equivalents and step-children, to retain any investment held
through the family office at the time they cease being a family
member. However, the proposed rule would limit former family
members from making any new investments through the family office.
Please note that the proposed rule would permit the family office
to provide investment advice with respect to additional investments
that the former spouse or spousal equivalent was contractually
obligated to make and that relate to a family office advised
investment existing prior to the time the person ceased being a
spouse or spousal equivalent.
Key Employees – The Proposed Rule
202(a)(11)(G)-1(d)(6) would permit the family office to provide
investment advice to any natural person 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 who, in connection with his or her regular
duties, has participated in the investment activities of the family
office or duties for or on behalf of another company for at least
twelve months. The Commission is creating a new standard that would
limit employee participation to those employees that are likely to
be in a position or have a high level of knowledge and experience
in financial matters sufficient to be able to evaluate the risks
and take steps to protect themselves. This new definition of key
employees is based on the "knowledgeable employee
standard" currently contained in Rule 205-3(d)(iii) of the
Advisers Act, which specifies the types of clients to whom advisers
may charge performance fees. Similar to its treatment of former
spouses, spousal equivalents and step-children, the proposed rule
would not permit former employees to make additional investments
through the family office but would not require them to liquidate
or transfer their investments out of the family office.
Ownership and Control – Proposed Rule
202(a)(11)(G)-1(b)(2) provides that, in order to qualify for
exemptive relief, the family office must be wholly owned and
controlled, either directly or indirectly, by family members. The
previous tests regarding profit generation and fees are no longer
applicable. The sole standard will be ownership and control by
family members. The Commission is seeking comment whether it should
permit minority ownership interest by non-family members.
Holding Out – The prohibition that a
family office not hold itself out as an investment adviser is
consistent with current practice.
Grandfathering Provisions
In accordance with the provisions of the Dodd-Frank Act, all existing family office persons not registered or required to be registered on January 1, 2010, may continue to provide investment advice without registration under the Advisers Act provided that prior to January 1, 2010, they provided such advice (i) to natural persons who have already invested with the family office and who are accredited investors as defined in Regulation D under the Securities Act of 1933; (ii) to any company owned exclusively and controlled by one or more family members; or (iii) to any investment adviser registered under the Act that provided investment advice to the family office. Please note that to the extent a family office is exempt from the definition of "investment adviser" by virtue of the grandfathering provision, the family office will nevertheless be deemed an investment adviser for purposes of certain antifraud provisions of the Advisers Act, namely Sections 206(1)(2) and (4) thereunder.
Should you wish to comment on the Proposed Rule, you have until November 18, 2010.
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.