As part of the ongoing rulemaking initiatives contemplated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Securities and Exchange Commission (“SEC”) recently released a proposed rule defining “family offices” for purposes of an exemption from registration under the Investment Advisers Act of 1940 (the “Advisers Act”).
Many family offices historically have not registered as investment advisers with the SEC, relying on the exemption found in Rule 203(b)(3) under the Advisers Act, which provides that investment advisers with fewer than 15 clients are not required to register. The Dodd-Frank Act repeals this so-called “private adviser exemption,” but includes a new exemption for family offices and mandates that the SEC adopt a formal definition of “family office” prior to July 21, 2011. Set forth below is a summary of the proposed rule. Please note that this is only in proposed form and is subject to change.
The Proposed Rule
Under the proposed rule, a “family office” is any company that (1) provides investment advice only to “family clients,” (2) is wholly owned and controlled by “family members,” and (3) does not hold itself out to the public as an investment adviser.
“Family members” include the founding member of the family office and his or her spouse or spousal equivalent, together with such persons’ lineal descendants (which includes adoptive and step children), parents, siblings, siblings’ lineal descendants, and any spouses or spousal equivalents of any of the forgoing persons.
“Family clients” include family members, certain key employees, charities established and funded exclusively by one or more family members or former family members, entities wholly owned and controlled (directly or indirectly) exclusively by, and for the sole benefit of, one or more family clients (provided the entities are not “investment companies” as defined under the Investment Company Act of 1940), and trusts or estates solely benefitting one or more family clients.
Notably, former family members (ex-spouses and former step-children) may maintain an investment in an entity managed by an exempt family office provided that they made such investment while a family member, but may not acquire new investments. In addition, family clients may not transfer investments managed by an exempt family office to non-family clients. If an involuntary transfer occurs (e.g., by reason of a family client’s death or similar circumstance), the proposed rule permits a four-month grace period to allow an exempt family office either (1) to cause another adviser to provide advice for the investment owned by a non-family client or (2) to transfer the asset to a family client. There is no transition period for voluntary transfers.
If a family office does not meet the definition of family office contained in the proposed rule, it may still apply to the SEC for an exemptive order.