On June 22, 2011, the SEC adopted final rules to exempt “family offices” from regulation under the Investment Advisers Act of 1940. Historically, many family offices either relied upon a “private adviser” exemption from the Investment Advisers Act or sought and received exemptive orders from the SEC based on their particular facts and circumstances. However, the Dodd-Frank Wall Street Reform and Consumer Protection Act repealed the “private adviser” exemption in order to cause advisers to private funds, such as hedge funds, to be subject to the Investment Advisers Act. This repeal also had the effect of removing the exemption that many family offices relied upon, and to remedy this foreseen consequence, the Dodd-Frank Act required the SEC to formulate rules that exempt family offices from the purview of the Investment Advisers Act.

The final rules provide a transition period until March 30, 2012 for family offices that relied on the private adviser exemption to either register under the Investment Advisers Act or be satisfied that the new family office exemption is available.

Under the final rules, a family office will be exempt from the Investment Advisers Act if it meets three requirements.  

  1. Only Family Clients

First, the family office may only advise family clients. “Family clients” include:  

  • 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 or, if both family clients and charitable and non-profit organizations are the sole current beneficiaries, trusts funded solely by family clients;
  • revocable trusts funded solely by family clients;
  • certain trusts of key employees; and
  • companies wholly owned exclusively by, and operated for the sole benefit of, family clients (with certain exceptions).

A “family member” includes all lineal descendants of a common ancestor (who may be living or deceased) as well as current and former spouses or spousal equivalents of those descendants, provided that the common ancestor is no more than 10 generations removed from the youngest generation of family members. Lineal descendants include foster and adopted children, stepchildren and individuals that were a minor when another family member became a legal guardian of that individual.

Unlike the proposed rules which defined family members by reference to the founder of the family office, the final rules use a common ancestor chosen by the family as reference. In order to prevent the selection of an extremely remote ancestor, the final rules impose a 10-generation limit between the oldest and youngest generations of the family being advised by the family office. However, the family may change the designation of the common ancestor over time which would allow the family office to advise new younger generations, but such a change would operate to preclude the family office from advising certain branches of a family that the office was previously able to advise.

A “key employee” means an executive officer, director, trustee, general partner or person serving in a similar capacity of the family office who, in connection with his or her regular duties, participates in the investment activities of the family office and has been performing such duties for the family office, or substantially similar duties for another company, for at least 12 months.

The final rules treat as a family client 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 funded exclusively by one or more other family clients. However, the SEC recognizes that some family offices advise charitable or non-profit organizations that have accepted funding from non-family clients and has included a transition period until December 31, 2013 for compliance with this specific requirement. To rely on this transition period, the charitable or non-profit organization must not accept additional funding other than from family clients after August 31, 2011, except that funding pledged prior to such date may be accepted.

  1. Ownership and Control

The second requirement for the family office is that it be wholly owned by family clients and exclusively controlled, directly or indirectly, by one or more family members or family entities. The final rule expands the proposed rule, which would have required ownership by family members rather than family clients. As certain key employees are included as family clients, the change would permit key employees to own a non-controlling stake in the family office to serve as part of an incentive compensation package for key employees.

  1. Holding Out to Public

Lastly, a family office relying on the exemption would be prohibited from holding itself out to the public as an investment adviser. Doing otherwise would be inconsistent with the basis for the SEC’s prior exemptive orders relating to family offices and the rationale for the exemption for family offices.  

Grandfathering Provision

The final rules include a grandfathering provision that precludes the SEC from excluding certain family offices from meeting the new exemption solely because they provide investment advice, and was engaged prior to January 1, 2010 in providing such advice, to certain clients.