SEC Releases New Rule on Family Offices for IA Registration Exclusion
The Dodd-Frank Act created a new “family office” exclusion from the definition of investment adviser because the private advisor exemption was repealed. While Congress believed that family offices should not be subject to the SEC registration requirements, it did grant authority to the SEC to define what constitutes a “family office”. On June 22, 2011 the SEC issued a final rule which narrowly defined a family office to essentially include only an office which represents a single family that does not exceed 10 generations. The new regulation takes effect on August 29, 2011 and those companies which do not fall within the new family office definition will be required to register with the SEC by March 30, 2012.
Family Office Definition
The term “family office” means a company that :
- provides investment advice only to certain “family clients”;
- is wholly owned by the “family clients” and controlled by family members or family entities; and
- does not hold itself out to the public as an investment adviser.
The term “family clients” includes:
- current and former family members,
- certain employees of the family office (and, under certain circumstances, former employees),
- charities funded exclusively by family clients,
- estates of current and former family members or key employees,
- trusts existing for the sole current benefit of family clients,
- revocable trusts funded solely by family clients,
- certain key employee trusts, and
- companies wholly owned exclusively by and operated for the sole benefit of, family clients.
The term “family member” includes:
- all lineal descendants of a common ancestor (who may be living or deceased)*
- current spouses or spousal equivalents of those descendants
- former spouses or spousal equivalents of those descendants
* The common ancestor cannot be more than 10 generations removed from the youngest generation of family members. For an example of how this works, please see this ancestor diagram.
Notably, the exclusion does not extend to family offices serving multiple families.
Also, it is important to note that family offices are excluded from the definition of investment adviser as opposed to being exempted from registration requirements. Previously family offices would have been exempt from registration because of the private adviser exemption.
Grandfathering Provision & Exemptive Orders
The Dodd-Frank Act included a grandfathering provision that precluded the SEC from excluding certain persons from the definition of “family office” solely because those persons provide investment advice to certain clients and provided that advice prior to January 1, 2010. The SEC’s rule incorporated that grandfathering provision such that employees of a family officer who are accredited investors (as defined by Regulation D) and companies controlled by a family member are permitted clients of a family office.
A family office that previously received a SEC exemptive order under section 202(a)(11)(G) of the Advisers Act will be able to continue to rely on the exemptive order and will thus not be required to register as an investment adviser.
The family office definition may have received more attention recently than it normally would have because of the Soros news. However, it seems more important that the new rule does not include in the definition those groups which provide advisory services to more than one family. This means that groups traditionally deemed to be family offices (albeit that services were provided to multiple families) will need to register with the SEC by March 30, 2012. While we encourage managers to begin the registration process as soon as possible, we believe that managers will not begin the process en mass until the fourth quarter of 2011 and into the first quarter of 2012.
The full rule is reprinted below.
The full adopting release can be found here: IA-3220 – Final Family Office Rule.
§ 275.202(a)(11)(G)-1 Family offices.
(a) Exclusion. A family office, as defined in this section, shall not be considered to be an investment adviser for purpose of the Act.
(b) Family office. A family office is a company (including its directors, partners, members, managers, trustees, and employees acting within the scope of their position or employment) that:
(1) Has no clients other than family clients; provided that if a person that is not a family client becomes a client of the family office as a result of the death of a family member or key employee or other involuntary transfer from a family member or key employee, that person shall be deemed to be a family client for purposes of this section 275.202(a)(11)(G)-1 for one year following the completion of the transfer of legal title to the assets resulting from the involuntary event;
(2) Is wholly owned by family clients and is exclusively controlled (directly or indirectly) by one or more family members and/or family entities; and
(3) Does not hold itself out to the public as an investment adviser.
(c) Grandfathering. A family office as defined in paragraph (a) above shall not exclude any person, who was not registered or required to be registered under the Act on January 1, 2010, solely because such person provides investment advice to, and was engaged before January 1, 2010 in providing investment advice to:
(1) Natural persons who, at the time of their applicable investment, are officers, directors, or employees of the family office who have invested with the family office before January 1, 2010 and are accredited investors, as defined in Regulation D under the Securities Act of 1933;
(2) Any company owned exclusively and controlled by one or more family members; or
(3) Any investment adviser registered under the Act that provides investment advice to the family office and who identifies investment opportunities to the family office, and invests in such transactions on substantially the same terms as the family office invests, but does 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 represents, in the aggregate, not more than 5 percent of the value of the total assets as to which the family office provides investment advice; provided that a family office that would not be a family office but for this subsection (c) shall be deemed to be an investment adviser for purposes of paragraphs (1), (2) and (4) of section 206 of the Act.
(d) Definitions. For purposes of this section:
(1) Affiliated Family Office means a family office wholly owned by family clients of another family office and that is controlled (directly or indirectly) by one or more family members of such other family office and/or family entities affiliated with such other family office and has no clients other than family clients of such other family office.
(2) Control means 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.
(3) Executive officer means the president, any vice president in charge of a principal business unit, division or function (such as administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions, for the family office.
(4) Family client means:
(i) Any family member;
(ii) Any former family member;
(iii) Any key employee;
(iv) Any former key employee, provided that upon the end of such individual’s employment by the family office, the former key employee shall not receive investment advice from the family office (or invest additional assets with a family office-advised trust, foundation or entity) other than with respect to assets advised (directly or indirectly) by the family office immediately prior to the end of such individual’s employment, except that a former key employee shall be permitted to receive investment advice from the family office with respect to additional investments that the former key employee was contractually obligated to make, and that relate to a family-office advised investment existing, in each case prior to the time the person became a former key employee.
(v) Any non-profit organization, charitable foundation, charitable trust (including charitable lead trusts and charitable remainder trusts whose only current
beneficiaries are other family clients and charitable or non-profit organizations), or other charitable organization, in each case for which all the funding such foundation, trust or organization holds came exclusively from one or more other family clients;
(vi) Any estate of a family member, former family member, key employee, or, subject to the condition contained in paragraph (d)(4)(iv) of this section, former key employee;
(vii) Any irrevocable trust in which one or more other family clients are the only current beneficiaries;
(viii) Any irrevocable trust funded exclusively by one or more other family clients in which other family clients and non-profit organizations, charitable foundations, charitable trusts, or other charitable organizations are the only current beneficiaries;
(ix) Any revocable trust of which one or more other family clients are the sole grantor;
(x) Any trust of which: (A) each trustee or other person authorized to make decisions with respect to the trust is a key employee; and (B) each settlor or other person who has contributed assets to the trust is a key employee or the key employee’s current and/or former spouse or spousal equivalent who, at the time of contribution, holds a joint, community property, or other similar shared ownership interest with the key employee; or
(xi) Any company wholly owned (directly or indirectly) exclusively by, and operated for the sole benefit of, one or more other family clients; provided that if any such entity is a pooled investment vehicle, it is excepted from the definition of “investment company” under the Investment Company Act of 1940.
(5) Family entity means any of the trusts, estates, companies or other entities set forth in paragraphs (v), (vi), (vii), (viii), (ix), or (xi) of subsection (d)(4) of this section, but excluding key employees and their trusts from the definition of family client solely for purposes of this definition.
(6) Family member means all lineal descendants (including by adoption, stepchildren, foster children, and individuals that were a minor when another family member became a legal guardian of that individual) of a common ancestor (who may be living or deceased), and such lineal descendants’ spouses or spousal equivalents; provided that the common ancestor is no more than 10 generations removed from the youngest generation of family members.
(7) Former family member means a spouse, spousal equivalent, or stepchild that was a family member but is no longer a family member due to a divorce or other similar event.
(8) Key employee means any natural person (including any key employee’s spouse or spouse equivalent who holds a joint, community property, or other similar shared ownership interest with that key employee) who is an executive officer, director, trustee, general partner, or person serving in a similar capacity of the family office or its affiliated family office or any employee of the family office or its affiliated family office (other than an employee performing solely clerical, secretarial, or administrative functions with regard to the family office) who, in connection with his or her regular functions or duties, participates in the investment activities of the family office or affiliated family office, provided that such employee has been performing such functions and duties for or on behalf of the family office or affiliated family office, or substantially similar functions or duties for or on behalf of another company, for at least 12 months.
(9) Spousal equivalent means a cohabitant occupying a relationship generally equivalent to that of a spouse.
(1) Any company existing on July 21, 2011 that would qualify as a family office under this section but for it having as a client one or more non-profit organizations, charitable foundations, charitable trusts, or other charitable organizations that have received funding from one or more individuals or companies that are not family clients shall be deemed to be a family office under this section until December 31, 2013, provided that such non-profit or charitable organization(s) do not accept any additional funding from any non-family client after August 31, 2011 (other than funding received prior to December 31, 2013 and provided in fulfillment of any pledge made prior to August 31, 2011).
(2) Any company engaged in the business of providing investment advice, directly or indirectly, primarily to members of a single family on July 21, 2011, and that is not registered under the Act in reliance on section 203(b)(3) of this title on July 20, 2011, is exempt from registration as an investment adviser under this title until March 30, 2012, provided that the company:
(i) During the course of the preceding twelve months, has had fewer than fifteen clients; and
(ii) Neither holds itself out generally to the public as an investment adviser nor acts as an investment adviser to any investment company registered under the Investment Company Act of 1940 (15 U.S.C. 80a), or a company which has elected to be a business development company pursuant to section 54 of that Act (15 U.S.C. 80a-54) and has not withdrawn its election.
Cole-Frieman & Mallon LLP is a hedge fund law firm which provides investment adviser registration and compliance services to hedge fund managers and other members of the investment management community such as family offices. Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.