Who Could Potentially Be Affected?
Persons providing investment advice to families, who may have previously relied on SEC guidance on family offices or on the "fewer-than-15" clients exemption for private advisers (eliminated by the Dodd-Frank Act), will want to determine if the SEC's new rule on "family offices" will provide an exemption from registration under the Investment Advisers Act of 1940.
Summary
Yesterday, the SEC released the final new rule exempting "family offices" from registration under the Advisers Act. An investment adviser that does not meet the new definition of family office and is of a size to require federal registration will be required to register with the SEC within the next two months, unless the adviser has fewer than 15 clients and does not hold itself out to the public as an investment adviser (or advise an SEC-registered fund or business development company), in which case the adviser will not be required to register with the SEC until March 30, 2012.
The final rule provides generally that:
- To be exempt, a family office must (i) only give
securities advice to family clients, (ii) be wholly owned and
controlled by family clients, and (iii) not hold itself out to the
public as an investment adviser. In response to
comments, the SEC broadened the definition of family members and
family clients significantly. However, not all persons who
may currently be considered to be part of "the family" by
a family office are covered. For example, charitable
organizations created, but not entirely funded, by family clients,
as well as family employees who are not "key employees"
of the family office, are not considered family clients under the
final rule. There are, however, grandfathering provisions
(described below) that may provide some relief from the effects of
the new rule.
- Family members include descendants of a common ancestor
not more than 10 generations removed. The SEC eliminated
the concept of a "founder" that was in the proposed
rule. The rule now permits a family to choose a common
ancestor (who may be deceased) to define the family, whether or not
such ancestor created the wealth being managed. Also included
as "family members" are current and former spouses or
spousal equivalents of the descendants of that ancestor. All
children of such descendants (including by adoption, stepchildren,
foster children and children whose legal guardian is a family
member) up to the 10th generation, also are considered family
members.
- The definition of "family clients" has been
broadened significantly, yet some current clients of a family
office may not be included. A family office may advise
only "family clients," including:
- Family members and former family members
- Certain key employees of the family office (and, under certain
circumstances, former employees), all as defined in the rule
- Charities funded exclusively by family clients
- Estates of current and former family members, key employees and
in some circumstances former key employees
- Trusts existing for the sole current benefit of family clients or, if both family clients and charitable and nonprofit organizations are the sole current beneficiaries, trusts funded solely by 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 SEC appears to have corrected certain unintended exclusions
from the definition of "family client" in the proposed
rule. For example, trusts no longer need to be for the sole
benefit of family clients, and can be for the benefit of charitable
organizations as well as family clients, so long as exclusively
funded by family clients.
- A special transition period is permitted for charities
with non-family funding. As noted above, a family office
may not avail itself of the exemption if it provides investment
advice to clients that are nonprofit organizations, charitable
foundations, charitable trusts and other charitable organizations
that are partially funded by non-family clients. Under a
special transition rule, however, charitable organizations that are
partially funded by non-family clients can remain clients of the
family office until December 31, 2013, provided the organizations
do not accept any additional funding from such non-family donors
after August 31 of this year.
- Key employees of the family office (and their spouses) count as family clients, but not with respect to new investments made after retirement. This definition follows closely the SEC's "knowledgeable employee" definition and covers only senior personnel participating in investment activities of the family office. This definition does not cover persons providing solely clerical or administrative services. Requests to include employees who are "key" to other family-owned businesses were rejected by the SEC. However, a family office will not lose its exemption because it provides advice with respect to investments made by any officer, director or employee of the family office (whether or not a key employee) before January 1, 2010, provided that he or she is an accredited investor.
- The family office must be family owned and controlled. To benefit from the exemption, a family office must be wholly owned by family clients (which includes key employees) and exclusively controlled (directly or indirectly) by one or more family members and/or family entities (which expressly excludes key employees as well as other non-family parties). Some family offices may need to restructure themselves to eliminate nonfamily ownership and/or control, if they wish to avoid SEC registration.
- Prior SEC orders given to family offices exempting them from registration remain in effect. The Staff determined not to rescind exemptive orders previously issued to family offices even though some of those orders may be broader than the final rule, and some may be narrower.
Background
For additional background information on the family office exemption under the previously proposed rule, please see our October 19, 2010 Financial Services Alert.
Next Steps
Investment managers who believe that they fit within the definition of "family office" should check the definitions and the grandfathering provisions in the final rule carefully to see if they meet every element of the rule. Family offices may need to transition some clients who do not meet the definition of "family clients" to other advisers, if the family office does not wish to register. Note that this rule only applies to investment advice with regard to securities. Family offices can continue to provide other types of administrative services and support to such persons. Advisers who have 15 or more clients and cannot transition clients and/or restructure to bring themselves in compliance with the rule by its effective date (60 days after its publication in Federal Register) may need to register with either with the SEC or state authorities, unless another exemption is available.
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