Tag Archives: investment adviser registration

New IA Rules in Washington State

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Amendments to Investment Adviser Rules in Washington State

Washington State Department of Financial Institutions has amended the rules governing the registration and activities of investment advisers set forth in Chapter 460-24A WAC. Effective July 13, 2014, the amendments update various provisions, including examination and registration requirements, financial reporting requirements, custody, performance compensation arrangements, books and records requirements, and unethical business practices. There are new rules addressing compliance policies and procedures, proxy voting, and advisory contracts. In addition, there are new exemptions from registration for certain private fund and venture capital fund advisers. The amendments repeal WAC 460-24A-058, which defines when an application is considered filed; and make additional updates, clarifications, and changes to the rules.

The full text of the revised rules can be found here.  Some notable amendments:

Exemptions from Registration for 3(C)(7) Fund Advisers and Venture Capital Fund Advisers

The amendments created a new exemption from registration for investment advisers who provide advisory services solely to one or more qualifying private funds (as defined by the SEC Rule 203(m)-1, but excluding 3(c)(1) funds) or venture capital funds. In order to qualify for this exemption, investment advisers have to satisfy the following requirements: (i) an investment adviser and its affiliates are not subject to disqualification pursuant to WAC 460-44A-505(2)(d); and (ii) an investment adviser has to file with WA Securities Division same reports and amendments as an exempt reporting adviser is required to file with the SEC. The filings must be submitted electronically through IARD.

Compliance Policies and Procedures

The amendments codified the requirement that investment advisers registered or required to be registered in WA adopt and implement written compliance procedures designed to prevent violation of the securities laws.  Investment advisers must review the procedures at least annually, and designate an individual administering the adopted code of ethics.

Proxy Voting

The amendments make it unlawful for an investment adviser registered or required to be registered in WA to exercise voting authority with respect to client securities absent: (1) the implementation of written policies and procedures designed to ensure proxy voting will be in the best interests of clients and include how to address material conflicts that may arise between the investment adviser and the clients; (2) disclose to clients how they may obtain information on the investment adviser voted with respect to their securities; and (3) describe to clients the proxy voting policies and procedures, and provide a written copy upon request.

Financial Reporting Requirements

The amendments created the following financial reporting requirements for investment advisers:

(1) An investment adviser with custody of client accounts must submit an audited balance sheet within 120 days of the end of the adviser’s fiscal year. Each balance sheet must be prepared in conformity with generally accepted accounting principles, audited by an independent certified public accountant, and accompanied by an audit opinion of the accountant.
(2) An investment adviser with custody of client accounts that manages pooled investment vehicles must provide audited financial statements of each pooled investment vehicle of which the investment adviser is a general partner (or comparable position) within 120 days of the end of the pooled investment vehicle’s fiscal year.
(3) An investment adviser who does not have custody of client accounts must submit a yearly unaudited balance sheet within 120 days of the end of the adviser’s fiscal year.

New Custody Requirements for Investment Advisers that Manage a Pooled Investment Vehicle

The amendments created new safekeeping and reporting requirements for investment advisers that manage a pooled investment vehicle. Such advisers must: (a) enter into a written agreement with an independent party to review all fees, expenses, and capital withdrawals from the pooled accounts and approve all payments; or (b) provide audited financial statements of the pooled investment vehicle to all limited partners within 120 days of the end of the pooled investment vehicle’s fiscal year. Further, investment advisers that manage a pooled investment vehicle must deliver account statements at least quarterly to all limited partners in accordance with WAC 460-24A-105 and include the following information:

(1) The total amount of all additions to and withdrawals from the fund as a whole, as well as the opening and closing net asset value of the fund at the end of the quarter;
(2) listing of the fund’s long and short positions on the closing date of the statement; and
(3) The total amount of additions to and withdrawals from the fund by the investor, as well as the total value of the investor’s interest in the fund at the end of the quarter.

Conclusion

Washington state investment advisors should review their practice to determine if they must implement new procedures in order to comply with the amendments. For individuals who are considering becoming an investment adviser in Washington, it will be important to review the new examination and registration requirements.  If you have any questions or would like assistance, please contact us.

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Cole-Frieman & Mallon LLP provides legal services for hedge fund managers and other groups within the investment management industry.  Bart Mallon can be reached directly at 415-868-5345.

California Private Fund Adviser Exemption Approved

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California Hedge Fund Managers Relieved of IA Registration Requirement

On August 27, 2012 (“Effective Date”), the California Office of Administrative Law approved the long awaited private fund adviser exemption (“Private Fund Exemption”). The immediately effective exemption is only available to advisers who provide advice solely to “qualifying private funds,” which include venture capital funds, Section 3(c)(1), and Section 3(c)(7) funds. The Private Fund Exemption is not available to advisers who also manage separate accounts.

Currently, a California based adviser who manages less than $100,000,000 must either register as an investment adviser with the California Department of Corporations (“Department”), or rely on an exemption from registration. Under the new Private Fund Exemption advisers can file as “exempt reporting advisers” (“ERAs”) and thereby avoid the burdensome registration process.

Requirements Generally

To qualify for the Private Fund Exemption, the adviser must

  1. have not violated any securities laws;
  2. file and periodically update certain items on Part 1 of the Form ADV;
  3. pay California’s investment adviser registration and renewal fees; and
  4. fulfill any additional requirements when advising funds organized under Section 3(c)(1).

Additional Requirements for 3(c)(1) Fund Managers

The additional requirements for advisers advising 3(c)(1) funds include:

1. All investors in the fund must either (i) be accredited investors; (ii) be managers, directors, officers or employees of the adviser; or (ii) have received the fund interest via a transfer not involving a sale.

2. Advisers may only charge performance fees to qualified clients; and

3. Advisers shall provide each investor with annual audited financial statement of the fund within 120 days after the end of each fiscal year; provided, however, advisers who begin operations more than 180 days into a fiscal year may include the audit of the initial fiscal year in the fiscal year immediately succeeding the initial fiscal year.

Other Information

An adviser to 3(c)(1) funds that existed prior to Effective Date may take advantage of the Private Adviser Exemption if, as of the Effective Date, it complies with the requirements enumerated above. Any investors in funds existing prior to the Effective Date who do not meet the standards outlined in Item 1 above, will be allowed to remain in the funds provided that they do not make any additional capital contributions. Furthermore, as of the Effective Date, advisers must cease charging performance fees to any investors who do not meet the “qualified client” definition.

To take advantage of the Private Fund Exemption, an adviser must file a partial Form ADV with the Department via the IARD system no later than 60 days from the Effective Date. Advisers currently registered with the Department may choose to withdraw their registration and make a filing under the Private Fund Exemption.

For information on whether your firm may be able to claim an exemption from registration, please see the California Private Fund Adviser Exemption Chart.

If you would like help to utilize the California exemption, please contact us directly.

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Bart Mallon is a partner with Cole-Frieman Mallon & Hunt LLP, an investment management law firm which provides legal services to the hedge fund industry. Bart can be reached directly at 415-868-5345.

SEC Guidance on Registration of Investment Advisory Affiliates

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The SEC’s Division of Investment Management issued a no-action letter on January 18, 2012 that provides guidance for registered investment advisers who have multiple entities in control relationships. The no-action letter affirms prior SEC guidance for investment advisers who have entities that serve as general partners and managing members to private funds and other similar special purpose vehicles (“SPVs”). Additionally, other investment advisers who “conduct a single advisory business” through multiple separate legal entities may use a single registration (i.e. register on a single Form ADV) under certain circumstances.

Affiliates Serving as Fund General Partners, Managing Members and Similar SPVs

Entities that function as fund general partners, fund managing members, and similar SPVs are not required to separately register as an investment adviser, as long as the following conditions are satisfied:

1. The investment adviser to a private fund establishes the SPV to act as the fund’s general partner or managing member;

2. The SPV’s formation documents designate the investment adviser to manage the private fund’s assets;

3. All of the investment advisory activities of the SPV are subject to the Investment Advisers Act of 1940 (the “Advisers Act”), Advisers Act rules, and SEC examination; and

4. All employees and persons acting on behalf of the registered investment adviser and/or an SPV are subject to supervision and control of the investment adviser.

For SPVs that have independent directors, the independent directors are excepted from the condition that they be under the registered investment adviser’s supervision and control, and thus are not “persons associated with” the registered investment adviser.

Other Investment Advisory Affiliates Under Common Control

Under the SEC’s guidance, a registered investment adviser (the “filing adviser”) can file a single Form ADV on behalf of itself and each entity that is controlled by or under common control with the filing adviser (each, a “relying adviser”) as long as those entities are conducting a single advisory business. Under the no action letter, using a single registration is appropriate under the following circumstances:

1. The filing adviser and each relying adviser advise only private funds and separate account clients that are “qualified clients” (as defined in Rule 205-3 promulgated under the Investment Advisers Act of 1940 (the “Advisers Act”));

2. Each relying adviser, its employees and the persons acting on its behalf are subject to the filing adviser’s supervision and control;

3. The filing adviser has its principal office and place of business in the United States;

4. The advisory activities of each relying adviser are subject to the Advisers Act and SEC examination;

5. The filing adviser and each relying adviser operate under a single code of ethics and single set of compliance policies and procedures; and

6. The filing adviser discloses in its Form ADV (Miscellaneous Section of Schedule D) that it and its relying advisers are together filing a single Form ADV and each relying adviser is identified by completing a separate Section 1.B, Schedule D, with the notation “relying adviser.”

For more information on whether the above guidance applies to your firm, please contact us directly.

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Cole-Frieman & Mallon LLP provides investment adviser registration and compliance services. Bart Mallon can be reached directly at [email protected] and by phone at 415-868-5345.

California Extends Hedge Fund IA Exemption Implementation

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Extension of Comment Period Delays Implementation of Private Adviser Exemption

As we have advised previously, states are responding to the Federal overhaul of investment adviser registration requirements by evaluating and in some

case changing their own laws governing investment advisers. This response, spearheaded by the National Association of Securities Administrators, or NASAA, includes exemptions for advisers to certain private funds.

In December, California’s Department of Corporations (the “Department”) released its own proposed exemption, which we discuss in detail here. In sum, the proposed rule, if

adopted, will exempt many hedge fund managers from registration with the state of California. The firm must provide advice solely to one or more “qualifying private funds,” which includes Section 3(c)(1), Section 3(c)(7) funds and certain other funds that fall under an Investment Company Act of 1940 exception. In addition, the adviser must:

  • have not violated securities laws;
  • file periodic reports (an abbreviated version of the Form ADV);
  • pay the existing investment adviser registration and renewal fees ($125); and
  • comply with additional safeguards when advising funds organized under Section 3(c)(1) (other than venture capital companies).

The initial deadline for comments on the proposal was February 20, 2012. However, the Department has extended that deadline to March 25, 2012.

While the rule is being considered, California has extended its existing private adviser exemption until April 19, 2012. If the new rule is not adopted by that time and the current exemption is not extended, those fund managers with over $25 million in assets under management must register in California. If however, the new rule is adopted, such managers will be exempt from registration. As long as their assets under management fall below $100 million, they will only have to file certain reports (similar to the reports filed by Exempt Reporting Advisers) with California. Once their assets under management exceed $100 million, they will have to register with the SEC unless an exemption applies (e.g. the Private Adviser Exemption).

The proposed exemption will significantly change the registration regime in California. Firms that solely manage qualifying funds and meet the additional requirements will not have to register and those that are currently registered may withdraw their registration. California fund managers with less than $100M in AUM generally will not be registered with any regulatory agency.

Conclusion

The original comment period ending February 20 gave California fund managers plenty of time to evaluate their current business, future plans and potential eligibility for the exemption prior to the deadline for the ADV Annual Updating Amendment (deadline March 31). With the comment period extended to March 25, and final adoption of the exemption likely pushed to early April, managers will now need to plan on filing their annual updating amendment as usual; managers whose registrations are pending should proceed with that process until the final rule is released.

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Cole-Frieman & Mallon LLP provides hedge fund and adviser registration services to managers throughout the United

States. Bart Mallon can be reached directly at 415-868-5345.

Investment Adviser Registration Presentation for Fund Managers

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Below is a press release on the investment adviser registration presentation we developed to help fund managers with the SEC registration requirements.

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Investment Adviser Registration Presentation for Fund Managers Released by Cole-Frieman & Mallon LLP

March 30, 2012 Deadline for SEC Registration Approaches

SAN FRANCISCO, CA – January 25, 2012 — Cole-Frieman & Mallon LLP, a leading boutique investment management law firm, is proud to announce the release of a presentation designed to help fund managers understand their registration obligations with the U.S. Securities and Exchange Commission. Many hedge fund managers who are not currently registered with the SEC will be required to be registered by March 30, 2012. Because of the application process, managers will need to submit their registration applications to the SEC by February 14, 2012. The presentation is posted on the Hedge Fund Law Blog at www.hedgefundlawblog.com/iaregistration2012.

The presentation, which includes a voice-over discussion, provides both hedge fund and private equity fund managers with a high level overview of the registration process and important compliance issues. “Most private fund managers have a general idea that they need to register with the SEC but many have delayed beginning the process,” said Bart Mallon, a partner with Cole-Frieman & Mallon LLP. “We developed this presentation to remind managers of the requirements but to also provide them with accurate information about what it means to go through the registration process and become registered with the SEC.”

In addition to information on the investment adviser registration process, the presentation also details compliance obligations of registered managers. “Fund managers tend to underestimate the importance of a proper SEC compliance program,” said Niel Armstrong, president of Gordian Compliance Solutions, a compliance consulting firm that offers fund managers outsourced SEC compliance solutions. “Implementing a robust compliance program that is tailored to a fund manager’s specific organizational structure is important from a regulatory perspective,

and many managers also find a business benefit when they employ compliance best-practices.”

Cole-Frieman & Mallon partner Aisha Hunt added “Fund managers generally have business specific needs that should be addressed during the SEC registration process. The presentation and supplementary information on the Hedge Fund Law Blog will provide those managers with the resources they need to understand the relevant business and compliance issues and begin the registration process.”

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About Cole-Frieman & Mallon LLP

Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive and cost-effective legal solutions for financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP has an international practice that services both start-up investment managers, as well as multi-billion dollar firms. The firm provides a full suite of legal services to the investment management community, including: hedge fund, private equity fund, venture capital fund, and mutual fund formation, adviser registration, counterparty documentation, SEC, CFTC, NFA and FINRA matters, seed deals, hedge fund due diligence, employment and compensation matters, and routine business matters. The firm also publishes the prominent Hedge Fund Law Blog (http://www.hedgefundlawblog.com), which focuses on legal issues that impact the hedge fund community. For more information please visit us at: www.colefrieman.com.

California Proposes Private Fund Adviser Exemption

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Hedge Fund Managers Exempt from Registration in California

As a general proposition, managers who are located in California must register as an investment adviser if they are providing investment advice for compensation.  There are exemptions from the registration requirement which we have detailed previously.  Because of the changes in the statutes and regulations at the Federal level, the states are changing their laws with respect to adviser registration.  Some states, such as California (see post), have adopted interim orders for certain advisers to address gaps in the Federal and state laws until state laws or appropriate regulations can be adopted.  California is proposing to adopt laws which would exempt many hedge fund managers from registration with the California Securities Regulation Division.

The proposed regulations if adopted would likely go into effect sometime in the first half of 2012.  The California Department of Corporations has requested comments on the proposal which may be submitted by February 20, 2012.  We have summarized the proposed exemption below and for more information, please see the following releases:

California Private Adviser Exemption Overview

If the proposed rule is approved, a manager would be exempt from registration as an investment adviser with the state of California if the manager meets the following requirements:

  • manager provides advice only to one or more “qualifying private funds” (includes Section 3(c)(1) funds and Section 3(c)(7) funds)
  • manager may not have not violated securities laws;
  • manager must file periodic reports with the Department of Corporations (an abbreviated version of the Form ADV);
  • manager must pay the existing investment adviser registration and renewal fees ($125); and
  • manager must comply with additional safeguards when advising funds organized under Section 3(c)(1) (other than venture capital companies). This includes:
    • only accredited investors may invest in the private fund;
    • the firm shall provided certain written disclosures about the services it provides, its duties, and other material information;
    • the firm shall obtain an annual audit of each fund and deliver them to each investor; and
    • performance fees can only be charged to qualified clients.

Firms may register with the SEC once they reach $100M in AUM. Therefore, the firm may rely on the California private adviser exemption and then, absent an exemption from SEC registration, register with the SEC at that point. Section 203(m) of the Adviser’s Act of 1940 (as amended by Dodd-Frank) provides such an exemption from such registration if the firm only manages private funds and has less than $150M AUM (the firm would be an exempt reporting adviser and would have to file the abbreviated Form ADV with the SEC).

Funds with Non-Accredited Investors

The proposed rule does have a grandfathering provision that will make the California private adviser exemption available to a firm that currently manages any Section 3(c)(1) fund that has non-accredited investors if the following requirements are met:

  • the fund existed prior to the effective date of the California private adviser exemption;
  • as of the effective date of the Private Adviser Exemption, the fund no longer accepts accredited investors;
  • the firm provides certain written disclosures about the services it provides, its duties, and other material information; and
  • as of the effective date of the Private Adviser Exemption, the firm delivers audited financials to the investors.

Currently, the proposed rule does not have an anticipated effective date. If approved, managers of funds with non-accredited investors may still qualify for the Private Adviser Exemption.

Conclusion

The California private adviser exemption will change the entire registration regime in California. Firms that solely manage qualifying funds and meet the requirements discussed above will not have to register with the DOC and those that are currently registered may withdraw their registration. So, hedge fund managers in California with under $100M in AUM generally will not be registered with any regulatory agency. Do keep in mind that if a manager manages even a single separate account, in addition to the qualifying funds, it will not be eligible for the private adviser exemption.

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Cole-Frieman & Mallon LLP provides investment adviser registration and compliance services to hedge fund managers.  Bart Mallon can be reached directly at 415-868-5345.

Alternative Mutual Funds Overview

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Hedge Fund Strategies Employed by Mutual Funds

Since the financial crisis of 2008, a growing number of retail investors have sought access to more sophisticated investment strategies to protect against downside risk.  Most retail investors are not eligible to invest directly in hedge funds so they have turned to mutual funds that employ alternative investment strategies to achieve greater diversification.  This increasing demand for alternative mutual funds is also fueled by hedge fund investors seeking greater transparency and liquidity, as well as more conservative investment strategies that are typically utilized by mutual funds.  Additionally, the Dodd-Frank Act restricts certain individuals and institutions from investing in hedge funds, which will likely force these investors to seek out “hedge-like” investment vehicles in which to invest the money formerly invested in hedge funds.  To accommodate these new investors and the converging demands of retail and hedge fund investors, investment managers have developed mutual funds designed to mimic hedge fund investment strategies to the extent permitted under federal securities laws.

What is an Alternative Mutual Fund?

An alternative mutual fund is a professionally managed, pooled investment vehicle, designed to provide individual investors with access to investment strategies that offer non-correlated returns and diversification benefits. Generally, the goal of alternative mutual funds is to minimize portfolio volatility and preserve return objectives. Strategies utilized by alternative mutual funds include traditional hedge fund investment strategies such as long-short, market neutral, arbitrage and merger/arbitrage strategies.

Starting an Alternative Mutual Fund – Legal Considerations

Some of the operational and legal steps for launching a mutual fund are similar to starting a hedge fund, but there are some important differences. The high-level legal steps to launch an alternative mutual fund include:

  1. Register the fund manager as an investment adviser with the SEC.
  2. Form a corporation or a business trust (or leveraging an existing business trust) – a mutual fund will typically be established as a Delaware statutory trust or Massachusetts business trust.
  3. Prepare and file Form N-1A with the SEC to simultaneously register the fund as an investment company under the Investment Company Act of 1940 (’40 Act) and register fund shares under the Securities Act of 1933. This filing includes the fund’s prospectus, which discloses the fund’s investment objective, investment strategies and principal investment risks, as well as other material information regarding the fund manager and the fund.
  4. Seed the fund (or fund family) with at least $100,000 as required by the ’40 Act.
  5. Choose a board of directors (or trustees). While board sizes vary, the ’40 Act requires that at least 40% of the directors on a board be independent. Typically, independent directors hold a majority (75%) of board seats in nearly 90% of fund complexes.
  6. Negotiate agreements with fund service providers, including a custodian, prime broker (for fund derivative transactions), transfer agent, fund accountant, independent auditor, administrator, financial printer, and distributor. [Note: some hedge fund service providers also provide services to mutual funds, but in general the service providers are likely to be different.]
  7. Draft fund compliance policies and procedures reasonably designed to detect, prevent, and resolve violations of federal securities laws.
  8. Make requisite blue sky filings (or notice filings) in states where fund shares will be sold.

Other Considerations

The ‘40 Act also imposes leverage and other investment restrictions on mutual funds. While some of these restrictions can be addressed by investing in ETFs and other investments, it is imperative that investment managers consult a ’40 Act attorney prior to launching an alternative mutual fund to fully understand the implications of regulatory restrictions on portfolio management.

Conclusion

Investor preference and regulatory developments are driving the convergence of mutual funds and hedge funds and resulting in a rapidly growing demand for mutual funds that employ hedge fund strategies. This demand is being met by the emergence of alternative mutual funds. The process of launching an alternative mutual fund varies depending on the complexity of the fund, however, these steps along with others can typically be completed in six months with the assistance of a seasoned ’40 Act attorney and other fund service providers.  For more information on registering a mutual fund and the regulations governing mutual funds, please see the SEC’s Investment Company Registration and Regulation Package or contact us.

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Cole-Frieman & Mallon LLP is a boutique investment management law firm with an alternative mutual funds law practice. Aisha Hunt, a Partner and the head of the ’40 Act practice at Cole-Frieman & Mallon LLP, can be reached directly at 415-762-2854.

 

Series 65 Exam Opinions Requested

Seeking Opinions on How to Pass to the Series 65 Exam

I am hoping readers of this blog would be able to provide some feedback on their experiences with the Series 65 exam. As a

little background, many of our firm's clients are managers who will be state registered investment advisers and therefor these groups will need to make sure certain individuals take the Series 65 exam in order to become registered in the state of principal residence.

The North American Securities Administrators Association (NASAA) is the group in charge of creating the Series 65 and the exam is administered by FINRA at any number of locations across the U.S. and in different countries. At the beginning of 2010 NASAA changed the grading of the Series 65 exam so that it was more difficult to pass. From that time forward we have anecdotally noticed that there were in fact less people who were passing the exam on the first try.  Accordingly, we are trying to gather information on the exam to help out those people who will be taking it in the future.

If you have taken the e

xam over the last year we are asking if you can provide us with a little information on your experiences and some thoughts on how you would prepare for the exam, given what you know now. For example, we think the following information would be helpful:

  • Date you took the exam (month, year)
  • Final score
  • Series 65 Exam prep / study guide(s) you used
  • Amount of time spent studying (approximate number of hours)
  • Number of practice exams you took? Scores on those exams?
  • Areas you did well on/ could have done better on
  • Overall impressions – was it similar to the practice exams?
  • How would you study for the exam differently?

If you have other comments or information that might be helpful, please feel free to post that as well.  Responses can be posted in the comment section below or you can contact us directly.

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Cole-Frieman & Mallon LLP is a boutique law firm focused on the hedge fund industry.  We help fund managers with investment adviser registration and hedge fund formation matters.  Bart Mallon can be reached directly at 415-868-5345.

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Bart Mallon Speaking at Financial Services Conference

Moss Adams Event on September 26, 2011

On September 26, 2011 Bart Mallon, co-managing partner of Cole-Frieman & Mallon LLP, is scheduled to speak on a panel with respect to recent regulatory issues affecting asset managers. The panel is entitled “Dodd-Frank and the Impact on the Asset Management Business” and also features David E. Tang, a partner at Sidley Austin LLP, and will be moderated by Bryan Cartwright of Moss Adams.

While we do not yet know the exact topics for the panel, there has been a number big picture issues which will affect fund managers over the next several months. Some of these issues include:

After the event we will

provide a review of the major items discussed during the panel.  An overview of the conference is reprinted below and more information can be found here.

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09/26/2011
9:00 a.m. – 5:00 p.m. PT
Hilton Hotel
San Francisco, CA

What’s happening in the investment community now, and where are asset management companies headed?

Join Moss Adams LLP, Arizona State University emeritus professor Dr. Stephen Happel, and US Bancorp former chief economist John Mitchell for an economic update. We’ll also discuss a range of issues and developments affecting broker-dealers, RIAs, hedge funds, and asset managers. Topics will include:

  • Impact of the Dodd-Frank Act
  • Retention and succession
  • Producing superior AUM growth
  • Transaction and advisory activity
  • Accounting and auditing roundup

Alongside our annual Community Banking Conference, this event will provide you an opportunity to network with banking professionals during lunch and at our joint reception.

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Cole-Frieman & Mallon LLP is a hedge fund law firm which provides comprehensive formation and SEC/CFTC regulatory support to start-up and established hedge fund managers.  Please contact us if you have any questions.

Bart Mallon

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Family Office Definition

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.

Our Thoughts

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.

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§ 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.

(e) Transition.

(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.

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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.

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