The SEC recently proposed Rule 202(a)(11)(G)-1 under the Investment Advisers Act of 1940 (Advisers Act) to define “family offices” that would be excluded from the definition of an investment adviser. Under the proposed rule:
- Family offices will qualify for the exclusion from regulation and registration if they provide securities advice exclusively to family clients, are wholly owned and controlled by family members and do not hold themselves out to the public as investment advisers.
- Family offices that do not meet the definition can seek exemptive relief from the SEC or register under the Advisers Act.
- Family offices that qualify for the exclusion only because of the grandfathering provision (discussed below) will still be subject to the Advisers Act antifraud provisions.
Many family offices, entities established by wealthy families to manage their wealth, have been structured to avoid registration under the Advisers Act by taking advantage of the Act’s exemption from registration for advisers with fewer than 15 clients that neither hold themselves out to the public as investment advisers nor advise any registered investment companies or business development companies. Other family offices have sought and obtained exemptive relief from the SEC. The Dodd-Frank Act repeals the 15-client exemption of the Advisers Act effective July 21, 2011. As a result, section 409 of the Dodd-Frank Act creates a new exclusion, under section 202(a)(11) of the Advisers Act, for family offices, as defined by the SEC. Family offices that meet the conditions defined below will not have to register under the Advisers Act or fulfill state registration requirements.
The proposed rule would define a family office, for purposes of the exclusion, as one that: 1) provides advice about securities only to family clients and certain key employees; 2) is wholly owned and controlled, either directly or indirectly, by family members; and 3) does not hold itself out to the public as an investment adviser.
A “family member” will include groups for which the SEC has previously given exemptive relief as well as others, including the individual and his or her spouse or spousal equivalent for whose benefit the family office was established and any of their subsequent spouses or spousal equivalents, their parents, their lineal descendants (including by adoption and stepchildren), and those lineal descendants’ spouses or spousal equivalents. Family clients are limited to: 1) family members; 2) key employees; 3) charitable foundations, organizations or trusts established and funded exclusively by a family member; 4) trusts or estates existing for the sole benefit of one or more family clients; and 5) any company that is wholly owned and controlled by one or more family clients and operated for the sole benefit of family clients.
The proposed rule will not preclude family offices that do not qualify under the Advisers Act from continuing operations. Family offices that fail to meet the SEC’s conditions may seek an exemptive order from the SEC or register under the Advisers Act unless another exemption is available. The SEC is not proposing to rescind exemptive orders issued to family offices because the policy behind these previously issued orders does not differ substantially from that of the proposed rule.
Finally, the proposed rule includes a grandfathering provision that includes persons not registered or required to be registered on January 1, 2010, who would meet all of the required conditions for Rule 202(a)(11)(G)-1 but for their provision of investment advice to certain clients specified in section 409(b)(3) of the Dodd-Frank Act in the definition of family office. A family office that would qualify for the exclusion only under the grandfathering provision would still be subject to the antifraud provisions of the Advisers Act.
The SEC specifically seeks comments on:
- including stepchildren, parents, siblings and their spouses or spousal equivalents and descendants, and former family members (under certain circumstances) in the definition of “family member”;
- the proposed definition of “family client”;
- including multifamily offices under this exclusion;
- the SEC’s approach to involuntary transfers and whether the rule should permit family clients to transfer assets advised by the family office to non-family clients if there is a death or other involuntary event without jeopardizing the ability of the family office to rely on the exclusion under the proposed rule;
- the SEC’s proposed treatment of investments by employees of the family office and who should qualify as a “key employee”;
- the condition that the family office be wholly owned and controlled by family members;
- the condition that the family office not hold itself out to the public as an investment adviser; and
- whether previous exemptive orders should now be rescinded.
The proposed rule can be found online at http://www.sec.gov/rules/proposed/2010/ia- 3098.pdf.