Recent Development

Family office key employees have new flexibility under recent SEC guidance regarding the nature and range of persons who can properly be involved in the administration of their trusts. 

Background

Family offices, which have existed for over a century, have been formed to implement very important and complex objectives, including investment management, corporate succession, estate, gift, and income tax planning, and charitable giving.  All these issues impact the day-to-day management of the now recognized family office industry.  Since the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act,[1] a family office that is an “investment adviser”—a person who, for compensation, is engaged in the business of giving investment advice to others—has been able to rely on Rule 202(a)(11)(G)-1 (“Family Office Rule”) under the Investment Advisers Act of 1940 (“Advisers Act”)[2] for exemption from all of the provisions of the Advisers Act.  The Family Office Rule provides that a “family office” must be a company that:[3]

1. 1. has no clients other than family clients;
   2. is wholly owned by family clients and exclusively controlled (directly or indirectly) by one or more family members and/or family entities; and
   3. does not hold itself out to the public as an investment adviser.

In addition to members of the family, family offices may choose to allow key employees of the family office to co-invest with the family office.  The term “key employee” is defined in paragraph (d)(8) of the Family Office Rule to mean a natural person (i) who is an executive officer,[4] director, trustee, general partner, or person serving in a similar capacity of the family office, and (ii) who, in connection with his or her regular functions or duties, participates in the investment activities of the family office.  This relatively simple definition is subject to several conditions.  First, the concept of key employee includes the key employee’s spouse or spousal equivalent who holds a joint, community property, or other similar ownership interest with that key employee.  Note that this expanded concept of key employee does not include the key employee’s former spouse(s) or the key employer’s children.  Second, the concept of key employee does not include an employee performing solely clerical, secretarial or administrative functions with regard to the family office.  Third, the key employee must have been performing such functions and duties for the family office or for another company for at least 12 months.  Fourth, in this paragraph the term “family office” is always used together with the term “affiliated family office,” which is itself defined in paragraph (d)(1) of the Family Office Rule as an alter ego of the family office.[5]  The second and third conditions described above are modeled closely after similar conditions in the definition of “knowledgeable employees” in Rule 3c-5 under the Investment Company Act.[6]

The Adopting Release discusses at length the provisions affecting key employees.  The SEC distinguishes sharply between the key employee and his spouse and the members of his family.  Specifically, subparagraph (d)(4)(x) of the Family Office Rule permits the key employee to invest through a trust subject to conditions intended to insure that only the key employee is able to make investment decisions.  As stated in the Adopting Release, “[t]here is no reason to believe that the key employee’s spouse or immediate family members independently have the financial sophistication and experience to protect themselves when receiving investment advice from the family office.”

New SEC Staff Guidance

In December 2014, the SEC staff issued additional guidance regarding key employee trusts.[7]  The SEC staff reiterated the requirement that the key employee be the investment decision-maker on behalf of the trust but expanded the range of tasks that a non-key employee (presumably, another family member or a non-family member accountant, lawyer, or bank trust officer) could perform for an otherwise qualifying key employee trust, including:

• • preparing and filing taxes for the trust;[8]
  • keeping records for the trust; or
  • distributing periodic statements or disclosures to trust beneficiaries.

The SEC staff noted, “While these and other administrative duties may result in a non-key employee making certain decisions on behalf of the trust, the [SEC] staff would generally not consider such decisions to be investment decisions."

Conclusion

The SEC staff has not deviated from the position in the Family Office Rule that the key employee must make the investment decisions for a key employee’s trust, but the new guidance has provided significant flexibility to key employees regarding the nature and range of persons who can properly be involved in the administration of their trusts.  This is a welcome development. 

© 2015 Perkins Coie LLP