Whither the Single-Family Office? New Rules Redefine Family Offices
We are just two months shy of the deadline for the SEC’s new rules on family offices, which could shake up the way the ultra wealthy manage their affairs and prompt some consolidation in the industry.
Many affluent families use “family offices” to provide such services as investment advice and tax and estate planning. These entities either serve a single family — a single-family office — or anywhere from a handful to dozens of families — a multifamily office. Family offices are becoming increasingly popular. In September, George Soros became one of the latest hedge fund moguls to return money from his investment operation, the Soros Fund Management, to outside investors and to convert to a family office. (For more on trends in the family office space, see this video webcast from the CFA Institute Wealth Management 2010 conference.)
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. But that was before the Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted in 2010. The act repealed the so-called “private adviser exemption” but included a provision requiring the SEC to define “family offices” and to exclude them from registration under the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.
In June the SEC adopted a new rule that defined “family offices” — and prompted consternation (and confusion) among many single-family offices.
In order to be excluded from regulation under the rule, the SEC said a family office must:
- Provide investment advice only to “family clients,” as defined by the rule;
- Be wholly owned by family clients and exclusively controlled by family members and/or family entities, as defined by the rule; and
- Not hold itself out to the public as an investment adviser.
Those entities that do not meet the terms of the exclusion will have to register with the SEC by 30 March 2012. With the deadline looming, many family offices are not clear on whether the rules apply to them. Richard C. Morais, a contributing editor at Barron’s, helped demystify it all with a helpful summary of some highlights from the SEC’s Q&A family office session, as reported in the Wolters Kluwer daily digest, SEC Today:
Example: A family office has seven directors on its board, four of which are family members. Under the office’s governing documents, each director has equal voting power and there are no minority veto rights. According to the SEC staffers, such a family office would be deemed a legitimate family office, exempt from onerous Investment Adviser regulations, because “this arrangement would satisfy the requirement that the family office be exclusively controlled by family members or family entities, assuming there are no special shareholder agreements or other arrangements that would give someone other than a family member control over the management or policies of the office.”
Translation: Any individual or firm hoping to use a family office as a front to bypass the Advisers Act is asking for trouble. The message from the SEC is clear. Genuine families only allowed.
Example: Members of the board are neither family members nor family entities. They have, however, been appointed by family members who have the right to appoint, terminate or replace the directors. The SEC staff said that in such a case, the “arrangement would not satisfy the exclusive control requirement unless the governing documents provide that matters relating to the management or policies of the office must be decided by shareholders that are family members or family entities. The right to appoint, terminate or replace board members does not satisfy the exclusive control standard.”
Translation: Having proxies sit in for family members doesn’t cut it. Conversely, what makes up “family” will be broadly interpreted by the SEC. “Same sex domestic partners and opposite sex partners who have chosen not to marry but live together in a relationship generally equivalent to married couples” will qualify as family members under the family office exclusion.
The SEC answered other meaty questions, such as how existing family office employees, even if they aren’t key, can get grandfathered under the new regulations so that they too can get financial advice and not undermine the family office’s exemption. We recommend calling your lawyer or the chief executive of your family office to find out the gritty details of the new SEC feedback.
According to the Family Wealth Alliance, a research and consulting firm, most single-family offices will probably qualify for the new exemption, though they may be forced to make operational or structural changes to avoid registration.
“Dodd-Frank has caused single-family offices to pause and take a look at themselves and to do a lot of introspection,” said Robert Casey, senior managing director for research at the Family Wealth Alliance. “A lot will throw in the towel and some are going to have to restructure.”
Some may decide that it’s time to outsource certain functions or join forces with other families under the umbrella of a multifamily office. This could be a boon for multifamily offices, which have been steadily gaining clients in recent years.
“A lot of single-family offices can qualify for the exemption with some tweaking, but all this ferment presents an opportunity for multifamily offices — they can pick up a lot of business,” Casey said. “Multifamily offices and single-family offices are very simpatico in terms of culture and attitude, and single-family offices are more likely to feel comfortable with a multifamily office than with some other financial provider.”
He added: “The smart multifamily offices are seeing a tremendous opportunity, and many are actively going after relationships with single-family offices. That doesn’t necessarily mean they will take them on as clients or fold them into their operations. They may provide some outsourced functions — for example, the investment function — so that the single-family office is no longer providing investment advice.”
The Family Wealth Alliance estimates there are about 150 multifamily offices in the U.S. with some $400 billion to $450 billion in assets under advisement. As for single-family offices, Casey said this area is “a little more murky.” He reckons there are about 3,000 single-family offices, with assets under advisement of between $1 trillion and $1.2 trillion.
To learn more, watch this Take 15 video in which Laird P. Pendleton discusses recent trends and changes in multi- and single-family offices, regional differences between the two models, and success factors for single-family offices during the financial crisis.
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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