Press Room: Tax Release

December 15, 2010

Family Office Announcement


As previously discussed in our July 2010 newsletter article, the Dodd-Frank Wall Street Reform and Consumer Protection Act repeals the so-called “private advisor exemption” that many family offices currently rely upon to avoid registration as investment advisers. Congress’ intent in repealing this exemption was primarily to require private funds to register, and therefore The Dodd-Frank Act directs the SEC to create a new exemption specifically for family offices.

The SEC recently released a proposed rule which defines “Family Offices” that would be excluded from the definition of an investment advisor, and thus would not be subject to the registration or other provisions of the Investment Advisers Act of 1940. The proposed rule indicates that the SEC does not want to regulate the traditional activities of single family offices in the management of their own wealth, including activities involving charities, tax planning and pooled investing. The proposed rule would also permit family offices to incentivize certain key employees by allowing them to invest alongside the family office. A grandfathering clause also accommodates certain pre-existing investments in pooled investments by non-family members so they will not be forced to divest in order for the family office to avail itself of the proposed exemption.

Under the proposal, a “Family Office” company—including its directors, partners, trustees, and employees acting within the scope of their position or employment—are exempt from the definition of investment advisor under the following conditions:

  1. The Family Office has no clients other than “Family Clients” as defined below
  2. It is wholly owned and controlled by family members; and
  3. It does not hold itself out to the public as an investment advisor

The proposed rule would limit a family office to providing investment advice to the following types of clients:

A.     Family Client

  • Any “Family Member,” including
    • Founder – person for whom the family office was established, plus current or future spouse or spousal equivalent
    • Founders’ lineal descendents (including by adoption and step-children)
    • Lineal descendants’ spouses or spousal equivalents
    • Founders’ parents
    • Founders’ siblings and those siblings’ spouses or spousal equivalents and lineal descendants (including by adoption and step-children)

    (NOTE: This definition would not include a founder’s uncles, aunts and cousins, or their descendents. Several commenters stated that the founder(s) of a family office may be one or more generations removed from the ancestor who created the family wealth, and requested the “founder” requirement by replaced entirely by a broader “common ancestor” test.)

  • Any “Key Employee, ” including
    • Executive officer, director, trustee, general partner, or person serving in a similar capacity of the family office or any employee of the family office who regularly 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 (i.e., “Knowledgeable Employees”)
    • Includes key employee’s joint, community property or similar shared ownership with spouse or spousal equivalent
    • Does not include employees performing solely clerical, secretarial or administrative functions
  • Any charitable foundation, charitable organization or charitable trust established and funded exclusively by one or more family members or former family members
  • Any trust or estate existing solely for the sole benefit of one or more family clients
  • 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
  • Any former family member
    • Spouse, spousal equivalent or stepchild who was a family member but no longer due to divorce or similar event
    • Former family member cannot add new assets to be managed after divorce, except for capital calls from previous private equity capital commitments

    (NOTE: Several commenters requested that the final rule permit former family members to contribute new assets to be managed without the family office losing its exemption.)

  • Any former key employee
    • Former key employee cannot add new assets to be managed after termination, except for capital calls from previous private equity capital commitments. 

B.     Temporary Non-Family Clients

  • Involuntary transfers of managed assets to a non-family member, such as an unrelated charity, upon the death of a family member or key employee may only be managed by the family office for four months following the involuntary transfer

    (NOTE: Several commenters requested that the final rule allow family offices to continue to manage assets involuntarily transferred to non-family members, or at least extend the grace period to two years to facilitate orderly divestiture.)

C.     Grandfathered Non-Family Clients

  • Officers, directors or employees of the family office who are accredited investors and invested with the family office prior to January 1, 2010
  • Any company owned exclusively and controlled by one or more family members
  • Registered investment advisors who identify investment opportunities and invests alongside the family office in that opportunity
    • Does not invest in other funds advised by the family office
    • Only up to 5% of the family office’s total AUM
    • The family office is still subject to antifraud provisions of the Advisers Act in this case

The second condition for the exemption requires the family office be wholly owned and controlled, either directly or indirectly, by family members. As proposed, family members must own 100% of the family office, while “control” would mean the power to exercise a controlling influence over the company’s management or policies of a company.

Unlike prior exemptive orders given to some family offices, the proposal would not require the family office to be operated without the intent of generating a profit.

(NOTE: Several commenters requested that minor non-family member ownership be permitted to accommodate minority interests to be held by non-family members such as key employees or non-family trustees.)

The third and likely simplest condition for the exemption would require that the family office does not hold itself out to the public as an investment advisor. This condition is scantly discussed, but the premise is that a family office holding itself out to the public as an investment advisor is likely a commercial business seeking out non-family clients.

The public comment period for ended and the SEC is scheduled to adopt a final rule for family offices in the second quarter of 2011. Given the breakneck pace of recent rulemaking, they may act more quickly. We expect the SEC’s final rule will incorporate many commenters’ suggestions which will allow more family offices to be exempt from the Investment Advisers Act, as Congress intended. Some family offices may need to consider taking actions prior to July 20, 2011 to avail themselves of the exemption. WTAS has subject matter experts available to discuss the impending requirements or assist with investment adviser registration if needed.
The SEC’s proposing release can be found here.