The SEC has proposed a rule pursuant to Section 409 of the Dodd-Frank Act to define “family offices” that would be excluded from the definition of an investment adviser under the Investment Advisers Act of 1940 (“Advisers Act”) and thus would not be subject to regulation under the Advisers Act. “Family offices” are entities established by wealthy families to manage their wealth, plan for their families’ financial future, and provide other services to family members. Single family offices generally serve families with at least $100 million or more of investable assets. Industry observers have estimated that there are 2,500 to 3,000 single family offices managing more than $1.2 trillion in assets.
Many family offices have been structured to take advantage of the exemption from registration under section 203(b)(3) of the Advisers Act for any adviser that during the course of the preceding 12 months had fewer than 15 clients and neither held itself out to the public as an investment adviser nor advised any registered investment company or business development company. Other family offices have sought and obtained orders from the SEC under the Advisers Act declaring those offices not to be investment advisers within the intent of section 202(a)(11) of the Advisers Act.
SEC exemptive orders have included conditions designed to distinguish between a “family office,” as described above, and a “family-run office” that, although owned and controlled by a single family, provides advice to a broader group of clients and much more resembles the business model common among many smaller investment adviser firms that are registered with the SEC or state regulatory authorities. Accordingly, SEC exemptive orders have limited relief to those family offices that provide advisory services only to members of a single family and their lineal descendants, with very limited exceptions.
Under the SEC proposal excluded family offices are not be permitted to have any investment advisory clients other than “family clients.” Family clients would include family members, certain employees of the family office, charities established and funded exclusively by family members or former family members, trusts or estates existing for the sole benefit of family clients, and entities wholly owned and controlled exclusively by, and operated for the sole benefit of, family clients (with certain exceptions), and, under certain circumstances, former family members and former employees.
The SEC proposes to define the term “family member” to include 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 such lineal descendants’ spouses or spousal equivalents.
The SEC proposal permits former family members, i.e., former spouses, spousal equivalents and stepchildren, to retain any investments held through the family office at the time they became a former family member. However, the proposal limits former family members from making any new investments through the family office.
The SEC proposes to treat as a “family client” any charitable foundation, charitable organization, or charitable trust established and funded exclusively by one or more family members and any trust or estate existing for the sole benefit of one or more family clients. Similarly, the SEC proposal would also treat as a family client any company, including a pooled investment vehicle, that is wholly owned and controlled, directly or indirectly, by one or more family clients and operated for the sole benefit of family clients.
The SEC also proposes to treat as family members certain key employees of the family office so that they may receive investment advice from and participate in investment opportunities provided by the family office. Such persons have been treated like family members in some of the SEC’s exemptive orders. The SEC believes permitting participation by key employees allows such family offices to incentivize key employees to take a job with the family office and to create positive investment results at the family office under terms that could be available to them as employees of other types of money management firms.
The proposal provides that to operate under the proposed exclusion from the Advisers Act the family office be wholly owned and controlled, either directly or indirectly, by family members. This condition generally is consistent with SEC exemptive orders and assures that the family is in a position to protect its own interests and thus is less likely to need the protection of the federal securities laws. The SEC believes this condition also helps distinguish family offices from family-run offices that may provide advice to other people, as well as other families, and operates as a more typical commercial investment adviser.
Consistent with prior exemptive orders, the SEC proposes to prohibit a family office relying on the rule from holding itself out to the public as an investment adviser. Holding itself out to the public as an investment adviser suggests that the family office is seeking to enter into typical advisory relationships with non-family clients, and thus is inconsistent with the basis on which the SEC has provided exemptive orders.
The SEC is not proposing to rescind the orders it has issued to family offices because it does not believe that the policy behind the previously issued orders differs substantially from that of the current proposal. Further, single family offices do not compete with one another and thus there is no need to rescind exemptive orders to create a “level playing field.” Family offices currently operating under these orders could continue to rely on those orders or, if they meet the conditions of proposed rule 202(a)(11)(G)-1, they could rely on the rule once it becomes final.