The no-action relief applies to family offices with at least US$50 million in total assets (Institutional Family Offices) and requires broker-dealers seeking to rely on the relief to establish and maintain specific additional policies and procedures.
On December 23, 2020, the Staff of the Division of Trading and Markets (Staff) of the US Securities and Exchange Commission (SEC) issued a no-action letter to the Securities Industry and Financial Markets Association (SIFMA) granting relief to broker-dealers from Regulation Best Interest (Reg BI) and Form CRS in relation to recommendations made to Institutional Family Offices under certain circumstances.
Whether family offices (which, as defined in Rule 202(a)(11)(G)-1 of the Investment Advisers Act of 1940 (Advisers Act), are not deemed "investment advisers" for purposes of the Advisers Act) were required to be treated under Reg BI and Form CRS (respectively) as "retail customers" or "retail investors" regardless of their size, had been an open question for the securities industry since the adoption of Reg BI and Form CRS in June 2019. In particular, although the definition of "institutional account" set forth in Rule 4512(c) of the Financial Industry Regulatory Authority, Inc. (FINRA) includes natural persons with total assets of at least US$50 million, neither Reg BI nor Form CRS contains any monetary threshold above which natural persons would no longer be considered retail customers or retail investors. Moreover, the retail customer and retail investor definitions include not only natural persons, but also "legal representatives" of natural persons. Although the SEC had previously indicated that the term "legal representative" would not include a "regulated financial services industry professional" such as a registered investment adviser or broker-dealer, the status of family offices and their professional personnel — who are not regulated or required to register under the Advisers Act given the exemption from the definition of investment adviser noted above — remained unclear.
The no-action letter brings welcome clarity to this area by providing comfort that the Staff will not recommend enforcement action if broker-dealers do not treat certain large family offices as "retail" for purposes of Reg BI or Form CRS. Nonetheless, the letter comes with its own set of conditions and requirements, as summarized below:
- Employment of Experienced Professionals. The broker-dealer must have a reasonable basis to believe, among other things, that the family office has employed one or more persons who are experienced in the securities industry or investment-related fields. In making its determination as to whether a person satisfies the experience requirement, the broker-dealer must, at a minimum, consider such matters as a person's length and quality of experience, registration history and exams taken, and education and professional credentials. SIFMA's letter states, by way of example, that a broker-dealer could form a reasonable basis to believe that a family office has retained an "experienced" financial services professional if such person has been a licensed securities industry professional for at least five years or has advised clients on securities or investment transactions for at least five years.
- "Institutional" Account Status. The broker-dealer must have a reasonable basis to believe that the family office manages total assets of US$50 million or more.
- Non-Reliance on Broker-Dealer. Similar to the representations required of institutional accounts to satisfy the "customer-specific" component of the suitability requirement under FINRA Rule 2111, the broker-dealer is required to obtain from the family office an acknowledgment that it is capable of evaluating investment risks independently and is exercising independent judgment in evaluating the broker-dealer's recommendations. The family office must also confirm that (i) it is a sophisticated investor with knowledge of the transactions it engages in with the broker-dealer, (ii) the family office professionals responsible for making investment decisions have not and will not accept any compensation or items of value from the broker-dealer that would cause them to not act in the best interest of the family clients, and (iii) the family office meets the "family office" definition under the Advisers Act.
- Policies and Procedures. The broker-dealer must establish policies and procedures reasonably designed to comply with the above requirements.
As outlined above, the requirements of the no-action letter largely follow the general contours of FINRA's existing regulatory framework around suitability for institutional accounts. However, in order to avail themselves of the no-action relief, broker-dealers will need to further supplement their existing policies, procedures, and forms relating to FINRA Rule 2111, Reg BI, and Form CRS.
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