Dodd-Frank and Family Offices: What You Need to Know

Categories: Private Wealth Management

Back in February I wrote about the US Securities and Exchange Commission’s new rules for family offices and the fact that some firms would have to register if they did not comply with the definition of what constitutes a family office. The deadline for compliance or registration has come and gone (31 March 2012), but questions still linger: What are the consequences of SEC registration? What are the issues in qualifying for exemption from registration? What are the alternatives if a family office does not qualify for exemption? And how likely is it that a family office will be penalized if it should, but does not, register?

First, a quick recap: Historically, single-family offices didn’t have to register with the SEC under the Investment Advisers Act of 1940 because of an exemption provided to advisers with fewer than 15 clients. Then the Dodd-Frank Wall Street Reform and Consumer Protection Act came along. The act, passed in 2010, repealed the so-called “private adviser exemption” but included a provision requiring the SEC to define “family offices” and to exclude them from registration under the new law. A family office is now defined as an entity that: has no clients other than family clients; is owned and controlled by family clients; and, does not hold itself out as an investment adviser.

To learn more about the SEC’s new rule for family offices, I tuned in to a recent webinar hosted by Financial Navigator, titled “The Effect of Dodd Frank on Family Office Regulation.” It was presented by David Guin, a partner in the law firm Withers Bergman. Guin spends a lot of his time advising domestic and international family offices, and their advisers, about obligations under US securities laws.

Here are the key takeaways from Guin’s presentation:

If you are a family office that does not qualify as a family office under the SEC’s definition and does provide investment advice, what do you need to do? What does registration mean to family offices?

  1. File Form ADV with the SEC, together with annual updates. Form ADV, which is publicly available and searchable in electronic format, includes information on ownership, structure, and asset values;
  2. Prepare a disclosure document that must be provided to clients on an annual basis;
  3. Designate or hire a chief compliance officer;
  4. Maintain books and records as required by the SEC;
  5. Comply with enhanced custody rules;
  6. Adopt a code of ethics, a conflict-of-interest policy, a business continuity plan, and other operational procedures as required by the SEC; and
  7. Be subject to examination and information requests by the SEC.

What are the common stumbling blocks?

  • Ownership and control. “A family office must be wholly owned by family clients, and a family client is any individual or entity — family members, family trusts, family companies, key employees,” Guin said. “The key employees can own portions of the family office and still have that family office qualify for the SEC exemption.” As for control, he noted that here the SEC is more restrictive. “A family office must be exclusively controlled by family members or family entities. The difference between a family client and family entity is primarily the fact that a family client can include key employees and a family entity cannot. Your key employees cannot control the family office, even though they can own a portion of it.”
  • Friends and in-laws. The most common problem, Guin said, is distant family and family friends (in-laws are not permissible as family clients). He provided an example in which in-laws present a problem. “If you have a family where you are going to the grandparents to create your common ancestor so all of the second-generation siblings will be able to be included in the family office, all of those people’s spouses would be able to be included in the family office, and all of their lineal descendants would be able to be included in the family office. But let’s say in generation two you have one of the brothers or sisters and their spouse in the structure and that spouse would like to include their brothers or sisters in the structure. If you include them, they will not qualify as family clients and that will cause the whole family office structure to fail the definition.”
  • “Private funds.” Guin said this area has been an issue for some of the families he has worked with and that it arises most frequently in the context of families that engage in direct private equity investing or families that have direct real estate investments. He explained: Say the “family believes that they are particularly good at private equity investing or real estate investing but are concerned that they have over-allocated their assets to that asset class. In order to perpetuate what they think is a good business for them and readjust their asset allocation, they bring in nonfamily money, and that money goes into entities that are controlled by the family office. That would create a nonfamily client and would cause the family office structure to fail.”
  • Charitable foundations. This is an issue when a family has a charitable foundation that has, for various reasons, accepted nonfamily donations.

How likely is it that I’m going to get caught?

This question, Guin said, is one that always comes up when he presents on the topic. “I don’t think the SEC has a ton of resources to run about and try and identify noncompliant family offices. That said, I believe they will — in the not-too-distant future — try and identify one or more noncompliant family offices to make the point that they are looking. That doesn’t mean they are going to devote substantial resources to try and root out all noncompliant family offices. I do think they will find a couple of noncompliant family offices and try to make an example of them,” he said.

“We think that the greatest risks for family offices are disgruntled family members and disgruntled employees. So someone who is unhappy about something and decides that a good way to get revenge is to give the SEC regional office a call and tell them they know about this noncompliant family office that ought to be registered. You should also be aware of the potential effect of the SEC’s new whistleblower rules will have on this; the SEC has incentivized people with the potential of monetary rewards to turn people in.”

If you have a family office that does not comply with the family office rule and doesn’t want to register the family office as a whole, what are the alternatives?

  • Create a “captive” investment adviser. That is, set up a wholly owned RIA and register that entity with the SEC.
  • Become part of a multifamily office structure.
  • Outsource to a professional investment adviser. (See “The Future of the Family Offices,” a blog post in which Philip Cave of Balentine, an independent investment adviser, discusses the “outsourced chief investment officer model.”)
  • Consider restructuring as an exempt entity. “The exempt entity that has gotten the most play at this point is a private trust company,” Guin said. “What we have typically told our clients is: ‘If you are considering a private trust company for other reasons, it can be a very useful way of avoiding SEC registration, but it probably isn’t a good idea to create a private trust company for the sole purpose of avoiding investment adviser registration.’ There are a number of reasons for this. The primary one is that if you are going to be exempt as a private trust company, your investment advice must be ancillary to your primary function of acting as a trustee.”
  • Seek an exemptive order. “If your family office technically does not meet the SEC’s definition of a family office, but you think there are good policy reasons why the SEC should still give your family office a pass, you can seek an exemptive order,” Guin said. “What an exemptive order does is it concedes you don’t satisfy the definition but asks for relief anyway. The risk there is if you write to the SEC and concede you don’t meet the definition and if they don’t agree with the policy reason why you should be exempt from registration, you have identified yourself as someone who should be registered.”

For more on this topic, here are some additional resources:


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

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