Family Offices May Be Subject to More Regulation
Historically, family offices have been exempt from the registration and compliance requirements that govern investment advisers and private investor funds. Now, some family offices may become subject to such regulation.
On July 21, 2010 President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), which includes the Private Fund Investment Advisers Registration Act (the “Registration Act”). The law substantially broadens the registration and compliance requirements for most investment advisers to private investor funds. Though the Act provides an exemption for family offices, it remains up to the United States Securities and Exchange Commission (the “SEC”) to adopt rules to define the term “family office.” Once these rules are in place, some family offices may be subject to regulation under the U.S. Investment Advisers Act of 1940.
Elimination of the Private Adviser Exemption
An “investment adviser” is an entity or person that advises others on securities investments. Such advisers are governed by the SEC and must comply with SEC rules relating to record keeping, compliance programs, soliciting clients, and so on.
Prior to the Act, the “private adviser” exemption exempted certain advisers from these SEC regulations, provided that the adviser:
- did not hold itself out generally to the public as an investment adviser
- had fewer than 15 clients during the preceding 12 month period, and
- was not an investment adviser to a registered investment company.
Among other things, the Act eliminated the private adviser exemption and requires many previously exempted financial advisers to register with the SEC under the Investment Advisers Act.
More Advisers Must Register with the SEC
The Registration Act significantly affects those advisers serving “private funds,” which means primarily hedge and private equity funds. Investment advisors to private investor funds with more than $150 million in assets under management (“AUM”) must register with and be regulated by the SEC. Advisers with less than $150 million in AUM are also subject to record keeping and annual reporting requirements.
Family Office Exemption
The Registration Act provides that “family offices” are excluded from the definition of “investment adviser.” But the SEC is required to adopt rules defining the term “family office.” The Act requires the SEC’s definition of “family office” to meet all of the following requirements:
- Provide an exclusion that is consistent with the SEC’s previous policies.
- Recognize the range of organizational, management, and employment structures adopted by family offices.
- Include a grandfathering provision that would include any family office that was not required to be registered on January 1, 2010 because it provides investment advice to:
- natural persons who are officers, directors, or employees of the family office and: i) invested with the family office before January 1, 2010, and ii) are accredited investors
- any company owned and controlled by members of the family of the family office, or
- any SEC-registered investment adviser who: i) provides investment advice and identifies investment opportunities to the family office, ii) invests in these opportunities on the same terms as the family office, iii) doesn’t invest in other funds advised by the family office, and (iv) whose assets to which the family office provides advice represent (in the aggregate) no more than 5% of the value of the total assets to which the family office provides investment advice.
Grandfathered family offices will still be subject to SEC enforcement authority with respect to anti-fraud provisions under the Adviser Act.
Once the SEC defines “family office,” any family office that does not meet the exemption will be required to register. All registered investment advisers will be required to report certain financial information to the SEC, and the records of any private fund advised by a registered investment adviser (over $150 million in AUM) will be “deemed to be the records and reports of such investment adviser.” Thus, all records of any investment vehicle with more than $150 million in AUM would be subject to SEC review. Some of the information provided to the SEC by a family office that is subject to the registration rules will become publicly available, and the SEC may require additional reports, all of which may limit the family office’s ability to maintain the confidentiality of private information.
Effect on International Family Offices
In addition to the family office exemption, the Registration Act also exempts any “foreign private fund adviser” from regulation. A foreign private fund adviser is defined as an adviser who:
- has no place of business in the U.S.
- has fewer than 15 U.S. clients
- has less than $25 million assets under management attributable to U.S. clients, and
- does not hold itself out to the public in the U.S. as an investment advisor, nor advises mutual funds or business development companies.
The Registration Act does not define what qualifies as “attributable to clients in the United States,” meaning that further SEC rulings will be required to determine how this requirement will be applied.
The Registration Act requires registered investment advisers to private funds to comply with additional reporting, recordkeeping, and disclosure requirements to the SEC and other third parties. These reports will also be provided to a newly created Financial Stability Oversight Council (the Council) for the assessment of systemic risk. The SEC may establish different reporting requirements for different classes of fund advisers. These records and reports may include:
- amount of assets under management
- the use of leverage, including off-balance-sheet leverage
- counterparty credit risk exposure
- trading and investment positions
- valuation policies and procedures
- types of assets held
- side arrangement or letters in which certain investors obtain more favorable rights and entitlements than other investors
- trading practices, and
- any other information that the SEC in consultation with the Council deems “necessary or appropriate in the public interest for the protection of investors or for the assessment of systemic risk.”
Because of the repeal of the private adviser exemption, and the lower limits for assets under management of foreign private advisers, unregistered investment advisers will very likely be subject to some new regulations. Family offices should carefully review the Act to determine whether they will be subject to additional regulation, and should monitor the SEC’s rulemaking as the definition of what constitutes a “family office” evolves. The tax advisors at Frank, Rimerman are available to assist you. For more information or if you have other questions, contact Karen Valladao.