Alert October 19, 2010

SEC Proposes Rule Creating New Exclusion from Investment Adviser Definition for Family Offices Pursuant to Dodd-Frank Act

As required under Section 409 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the SEC proposed Rule 202(a)(11)(G)-1 under the Investment Advisers Act of 1940, as amended (the “Advisers Act”).  The proposed rule would create a new exclusion from the definition of “investment adviser” for “family offices” that largely codifies prior SEC exemptive relief in this area, and would implement related grandfathering provisions.  Comments on the proposal are due on or before November 18, 2010. 

Background – Dodd-Frank Act’s Removal of the Private Adviser Exemption and Effect on Family Offices.  Family offices are entities established by wealthy families to manage their wealth and to provide other services, financial and otherwise, for family members.  Family offices and their employees may be compensated for their services.  If those services include providing advice about securities, the entities and the individuals who provide the advice may be subject to the Advisers Act, and required to register, absent an exemption or exclusion.  Many family offices rely on the “private adviser” exemption in Section 203(b)(3) available to an investment adviser that, during the preceding twelve months, has had fewer than fifteen clients, and neither holds itself out generally to the public as an investment adviser nor acts as an investment adviser to a registered investment company.  The SEC has also provided exemptive relief on a case-by-case basis to family offices that provide advisory services to more than fifteen persons.  The Dodd-Frank Act removes the private adviser exemption, effective July 21, 2011, but also adds a new exclusion from the definition of “investment adviser” in the Advisers Act for a “family office.”  The proposed rule is the result of an accompanying direction in the Act that the SEC define the term “family office” by rulemaking.

Definition of Family Office.  Proposed Rule 202(a)(11)(G)-1 would define “family office” as a company (including its directors, partners, trustees and employees acting within the scope of their position or employment) that (a) has no clients other than “family clients” (with some allowance for situations resulting from the death of a family member); (b) is wholly owned and controlled by family members; and (c) does not hold itself out to the public as an investment adviser.

“Family client” would be defined to include any (1) “family member”; (2) key employee (as defined in the rule); (3) charitable foundation, charitable organization or charitable trust established and funded exclusively by one or more family members or former family members; (4) trust or estate for the sole benefit of family clients; (5) corporate or similar entity wholly owned or controlled and operated for the sole benefit of family clients; and (6) former family members under limited conditions for existing investments or commitments.

“Family Members” would include: 

  • the founders of a family office, their lineal descendants (including by adoption and stepchildren) and the spouses or spousal equivalents of those lineal descendants;
  • the parents of the founders; and
  • the siblings of the founders, the siblings’ spouses or spousal equivalents, their lineal descendants (including by adoption and stepchildren) and those lineal descendants’ spouses or spousal equivalents.

Adopting the definition of that term as used in the SEC’s auditor independence rules, “spousal equivalent” would mean a cohabitant occupying a relationship generally equivalent to that of a spouse.  The proposing release points out that it has not previously provided exemptive relief for a family office whose clients included stepchildren or spousal equivalents, and seeks comment on those elements of the proposed rule.  The proposing release indicates that in conjunction with this rulemaking the SEC does not intend to rescind the exemptive relief it has previously provided to family offices, on the grounds that the relief provided by the proposed rule is substantially similar to the relief previously given.

Grandfathering.  The proposed rule includes a grandfathering clause that would allow persons to rely on the proposed “family office” exclusion, provided that (a) they were not registered or required to be registered as investment advisers with the SEC on January 1, 2010 and (b) they would meet the conditions of the proposed rule but for the fact that they provide advice to specified types of clients, and were engaged in doing so prior to January 1, 2010.  (The Dodd-Frank Act provides that a family office that relies on this grandfathering provision is nevertheless subject to the anti‑fraud provisions of paragraphs (1), (2) and (4) of Section 206 of the Advisers Act.)