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Thursday, 19 January 2017
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Oct 18 2010 | 9:34am ET
By John Brunjes and Genna Garver, Greenberg Traurig -- Since the passage of The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") this summer, family offices have faced great uncertainty as to its impact on their business. The Private Fund Investment Advisers Registration Act of 2010 will greatly expand the current registration requirements for investment advisers as of July 21, 2011.
The Registration Act also directs the Securities and Exchange Commission to create by rule a new exclusion from the Investment Advisers Act of 1940, as amended, under which certain family offices are not investment advisers subject to the Advisers Act. On October 12, 2010, the SEC issued proposed Rule 202(a)(11)(G)-1 under the Advisers Act to provide for an exclusion for any family office that:
- Provides investment advice only to certain family clients;
- Is wholly owned and controlled by family members; and
- Does not hold itself out to the public as an investment adviser.
Currently, family offices that are in the business of providing advice about securities for compensation are subject to the Advisers Act, including its registration requirements and anti-fraud provisions. Most family offices either rely on the so-called "private adviser" exemption from registration under Section 203(b) of the Advisers Act for advisers with fewer than fifteen clients, or have obtained from the SEC an order under the Advisers Act declaring those family offices not to be investment advisers within the intent of the definition of investment adviser under the Advisers Act.
The Registration Act, however, eliminated the Section 203(b) private adviser exemption, leaving many family offices with regulatory uncertainty. Much to the chagrin of family offices, the breadth of the exclusion from the definition of “investment adviser” will remain uncertain until the rule is finalized. Those family offices that meet the conditions of the exclusion will not be subject to regulation as investment advisers under the Advisers Act. Those family offices that will not be able to meet the conditions of the exclusion, however, must either seek an exemptive order from the SEC, or register with the SEC unless another exemption from registration is available. The SEC registration process and dealing with the ongoing regulation as a SEC-registered investment adviser may be a daunting task and intrude on the privacy of family members.
Section 408 of the Registration Act requires any rules, regulations, or orders issued by the SEC regarding the definition of the term “family office” to (i) be consistent with the SEC's previous exemptive policy for family offices in effect on July 21, 2010; (ii) recognize the range of organizational, management and employment structures and arrangements employed by family offices; and (iii) subject to certain conditions, grandfather certain family offices. The Proposed Rule provides for the exclusion, defines the term “family office” and other key terms, and grandfathers certain offices with clients who are key employees and other non-family members.
Proposed Definition of Family Office
The Proposed Rule would define “family office” as a company (including its directors, partners, trustees, and employees acting within the scope of their position or employment) that has no clients other than family clients; is wholly owned and controlled (directly or indirectly) by family members; and does not hold itself out to the public as an investment adviser. For purposes of the rule, the term “family clients” means:
- Family members. Any natural person and his or her spouse or spousal equivalent (a cohabitant occupying a relationship generally equivalent to that of a spouse) for whose benefit the family office was established and any subsequent spouse of such individuals, their lineal descendants (including by adoption and stepchildren), and such lineal descendants’ spouses or spousal equivalents; the parents of the founders; and the siblings of the founders and such siblings’ spouses or spousal equivalents and their lineal descendants (including by adoption and stepchildren) and such lineal descendants’ spouses or spousal equivalents.
- Key employees. Any natural person (including any person who holds a joint, community property, or other similar shared ownership interest with that person’s spouse or spousal equivalent) who is an executive officer, director, trustee, general partner, or person serving in a similar capacity of the family office or any employee of the family office (other than an employee performing solely clerical, secretarial, or administrative functions with regard to the family office) who, in connection with his or her regular functions or duties, participates in the investment activities of the family office, provided that such employee has been performing such functions and duties for or on behalf of the family office, or substantially similar functions or duties for or on behalf of another company, for at least 12 months.
- Family charities. Any charitable foundation, charitable organization, or charitable trust, in each case established and funded exclusively by one or more family members or former family members.
- Family trusts and estates. Any trust or estate existing for the sole benefit of one or more family clients.
-Certain family-owned entities. Any limited liability company, partnership, corporation, or other entity wholly owned and controlled (directly or indirectly) exclusively by, and operated for the sole benefit of, one or more family clients; provided that if any such entity is a pooled investment vehicle, it is excepted from the definition of “investment company” under the Investment Company Act of 1940, as amended.
- Certain former family members. Any spouse, spousal equivalent, or stepchild that was a family member but is no longer a family member due to a divorce or other similar event, provided that from and after becoming a former family member the individual shall not receive investment advice from the family office (or invest additional assets with a family office-advised trust, foundation or entity) other than with respect to assets advised (directly or indirectly) by the family office immediately prior to the time that the individual became a former family member, except that a former family member shall be permitted to receive investment advice from the family office with respect to additional investments that the former family member was contractually obligated to make, and that relate to a family-office advised investment existing, in each case prior to the time the person became a former family member.
- Certain former key employees. Any former key employee, provided that upon the end of such individual’s employment by the family office, the former key employee shall not receive investment advice from the family office (or invest additional assets with a family office-advised trust, foundation or entity) other than with respect to assets advised (directly or indirectly) by the family office immediately prior to the end of such individual’s employment, except that a former key employee shall be permitted to receive investment advice from the family office with respect to additional investments that the former key employee was contractually obligated to make, and that relate to a family-office advised investment existing, in each case prior to the time the person became a former key employee.
Any person that would become a client of the family office as a result of the death of a family member or key employee or other involuntary transfer from a family member or key employee, would be deemed to be a family client for four months following the transfer of assets resulting from the involuntary event.
Notably, the Proposed Rule does not extend the family office exclusion to every type of individual or entity that has been included in a prior exemptive order based on specific facts and circumstances, including individuals with close ties to the family. In addition, the Proposed Rule would not extend to the family office exclusion to family offices serving multiple families. In its proposing release, the SEC stated that is has never granted an exemptive order to a multifamily office and including them would seem inconsistent with its prior exemptive policy. The SEC also noted its concern that multifamily offices provide investment advice beyond family members and increasingly resemble a typical commercial/for-profit investment advisory business and not a family managing its own wealth. The SEC, however, did break from its prior exemptive policy in extending the exclusion to family offices with clients who are spousal equivalents, former family members and involuntary transferees.
The Proposed Rule also incorporates the grandfathering provisions of the Registration Act so that the definition of “family office” includes any person who was not registered or required to be registered under the Advisers Act on January 1, 2010, solely because such person provides investment advice to, and was engaged before January 1, 2010 in providing investment advice to:
- Natural persons who, at the time of their applicable investment, are officers, directors or employees of the family office who have invested with the family office before January 1, 2010 and are accredited investors as defined by Regulation D under the Securities Act of 1933, as amended;
- Any company owned exclusively and controlled by one or more family members; and
- Any SEC registered investment adviser that provides investment advice and identifies investment opportunities to the family office, invests in these opportunities on substantially the same terms, but does not invest in other funds advised by the family office, and whose assets as to which the family office directly or indirectly provides investment advice represents, in the aggregate, not more than five percent of the value of the total assets as to which the family office provides investment advice.
Importantly, any grandfathered family office would still be deemed an investment adviser for purposes of the anti-fraud provisions of the Advisers Act.
Implications of Being Excluded from the Exclusion — SEC Investment Adviser Regulation
Every family office that must register with the SEC as an investment adviser must file a Form ADV, which has two parts. Part 1 requires disclosure of the adviser's education, business, disciplinary history and ownership — for family offices, this includes public disclosure of the type of the family client and the amount of family assets under management. Part 2, which was recently amended, requires disclosure of the adviser's services, fees, and investment strategies. Many assume the process for SEC registration begins with filing Form ADV with the SEC. Indeed, Form ADV is the application for investment adviser registration, but is better characterized as the culmination of the registration process. The real work comes before Form ADV is filed-- the adviser must adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules. Advisers must also designate a chief compliance officer to be responsible for administering the compliance program. The chief compliance officer must be a "supervised person" of the adviser with knowledge of the Advisers Act, competence in establishing and maintaining a compliance program, and empowerment to compel others to adhere to the compliance program.
To create compliance programs, advisers will need to identify conflicts and other compliance factors creating risk exposure for the firm and its clients in light of the firm’s particular operations; create policies and procedures to address those risks; and then implement those policies and procedures. Many advisers already have industry "best practice" polices and procedures in place and may only need to review them to ensure their adequacy and effectiveness, while others may be starting from scratch.
Applicants for SEC registration are required to comply with all of the applicable provisions of the Advisers Act and its rules as of the day Form ADV is filed and thereafter, including, but not limited to:
- Updating Form ADV;
- Adopting a code of ethics designed to prevent fraud by adviser personnel;
- Maintaining books and records relating to their advisory business, which are subject to examination by the SEC; • Annually reviewing the compliance program for adequacy and effectiveness; and
- Maintaining assets with a qualified custodian, among other requirements set forth in the recently amended custody rule.
Regardless of the size of the family office, the process of registration and ongoing compliance is no small task. Unless the compliance dates are extended through rulemaking, family offices that must register with the SEC must be ready to file and compliant with the Advisers Act on or before June 7, 2011 to be sure there is time for the SEC to declare the registration effective before July 21, 2011.
The SEC has requested comments on the Proposed Rule, which must be received on or before November 18, 2010.
John Brunjes, shareholder at Greenberg Traurig, is a transactional securities lawyer who handles a wide variety of investment, transactional and governance matters for private investment funds and their sponsors/managers, as well as for domestic and international institutional and individual investors placing capital into these funds. He is a member of the Board of Directors of the Connecticut Hedge Fund Association, and serves on the Connecticut Banking Commissioner’s Securities Advisory Council. He was an Assistant Attorney General in Connecticut from 1990-1995, during which time he led and settled one of the largest securities fraud investigations ever brought against a public accounting firm in connection with investor losses in a multi-billion dollar Ponzi scheme.
Genna Garver is an of counsel in the Corporate Securities Practice of Greenberg Traurig’s New York office. She represents financial institutions in a variety of transactional and regulatory matters with a focus on investment advisers, hedge funds and other private investment funds. Genna advises clients on formation and offering matters for domestic and offshore funds, mergers and acquisitions, securities regulation, SEC and state investment adviser registration and exemptions, the development and implementation of Advisers Act compliance programs and procedures, ongoing compliance matters, mock audits and regulatory examinations. She also has counseled banking clients on complex structuring and capital issues regarding M&A, risk capital matters, affiliated transactions, and securities lending agency transactions.