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SEC Adopts Rule Defining “Family Offices” Under Dodd-Frank Act

Update
06.27.2011

SEC Adopts Rule Defining “Family Offices” Under Dodd-Frank Act

At an open meeting of the Securities and Exchange Commission (SEC) on June 22, 2011, the SEC Commissioners approved a new rule defining “family offices.”  Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) excluded family offices from the definition of investment adviser under the Investment Advisers Act of 1940 (Advisers Act) and thereby exempted family offices from the registration requirements under the Advisers Act, as amended by the Dodd-Frank Act. However, Section 409 of the Dodd-Frank Act also directed the SEC to adopt a rule defining the term “family office” in order to identify the entities eligible for the exclusion.  On June 22, 2011, the SEC adopted such a rule.

Family Offices Historically

The SEC has described family offices generally as “entities established by wealthy families to manage their wealth and provide other services to family members, such as tax and estate planning services.”  Because these entities typically provide investment advisory services to their family member clients, prior to the enactment of the Dodd-Frank Act, they would have been required to register with the SEC as an investment adviser if not for the “private adviser exception” provided in Section 203(b)(3) of the Advisers Act, which excepted private advisers with fewer than 15 clients from registration.

The Dodd-Frank Act repealed Section 203(b)(3), effective July 21, 2011, with the stated goal of enabling the SEC to regulate advisers to hedge funds and other privately offered investment vehicles.  However, the repeal of this provision also could have required most family offices to register with the SEC by July 21, 2011 if Congress had not included Section 409 of the Dodd-Frank Act, which excludes “family offices” from the definition of investment advisers subject to the registration requirements of the Advisers Act.

New Family Office Rule and Definition

As instructed by Congress, the SEC has adopted new Rule 202(a)(11)(G)-1 under the Advisers Act , which defines a family office as a company that: 

  • has no clients other than “family clients,” as defined by the rule; 

  • is wholly owned by “family clients” and is exclusively controlled by one or more “family members,” as defined by the rule; and 

  • does not hold itself out to the public as an investment adviser.
In order to meet this definition, a family office must limit the investment advisory services it provides to the following persons, each of which is defined as a “family client”: 
  • Family members – defined as all lineal descendants (including adopted children, stepchildren, foster children, and, in some cases, legal wards) of a common ancestor (who is no more than 10 generations removed from the youngest generation of family members), and such lineal descendants’ spouses or spousal equivalents. 

  • Key employees – defined as executive officers, directors, trustees, general partners or persons serving in a similar capacity for the family office or its affiliated family office (other than an employee only performing clerical, secretarial or administrative functions) who, in connection with his or her regular duties, has participated in the investment activities of the family office or affiliated family office, or performed similar functions or duties for another company, for at least 12 months. 

  • Former family members – defined as a spouse, spousal equivalent, or stepchild who was a family member but is no longer a family member due to a divorce or other similar event.

  • Any nonprofit or charitable organization funded exclusively by family clients.

  • Any estate of a family member, former family member, key employee, or, subject to certain conditions, former key employees.

  • Certain trusts of a family client, including  any irrevocable trust where other family clients are the only current beneficiaries; an irrevocable trust funded exclusively by family clients in which other family clients and nonprofit organizations are the only current beneficiaries; and any revocable trust where family clients are the sole grantors.

  • Certain trusts of key employees.

  • Any company that is wholly owned exclusively by, and operated for the sole benefit of, family clients.

Compliance Date

On June 22, the SEC also extended to March 30, 2012 the effective date of the repeal of the private adviser exception under the Advisers Act that family offices have traditionally relied on.  Family offices thus have until March 30, 2012 to meet the conditions of the definitional exclusion and registration exemption provided by new Rule 202(a)(11)(G)-1.  The SEC believes that this extended deadline provides family offices with sufficient time to evaluate whether they currently meet the definitional exclusion and to determine whether they will restructure their operations to meet the exclusion, register with the SEC, or seek to obtain an SEC exemptive order from the SEC.  The SEC noted in its new rule release that a family office that has obtained an exemptive order from the SEC in the past will be able to continue to rely on such existing order in order to avoid registration or it may decide to rely instead on the SEC’s new rule. 

Additional Information

This update is intended only as a summary of the highlights of the SEC’s open meeting. You can find the full text of the final rule at http://sec.gov/rules/final/2011/ia-3220.pdf. You can find discussions of other recent cases, laws, regulations, and rule proposals of interest to public companies on our website.

© 2011 Perkins Coie LLP