For single-family offices, a recent Securities and Exchange Commission ruling marked the beginning of an identity crisis writ large–one that will reshape the family office business and may ultimately benefit wealth and asset managers.
Before the Wall Street Reform and Consumer Protection Act (better known as Dodd-Frank) became law last summer, a family office did not have to register with the SEC under the Investment Advisers Act of 1940 if it had fewer than 15 clients. The new law eliminated that exemption, but directed the SEC to define family offices that would still qualify for exclusion from registering with the agency under the 1940 act.
According to the new SEC rule, issued late last month, family offices eligible for exclusion were defined as companies that provide investment advice only to family clients; are wholly-owned by family clients and exclusively controlled by family members and/or family entities and do not hold themselves out to the public as an investment advisor.
Under the exclusion, family offices can advise family members and key employees, all of whom are carefully defined, as well as other family clients, including non-profits funded exclusively by family members or key employees, certain estates and trusts and any company wholly-owned by family clients.
Of course, the devil is in the details. For example, a family office is not eligible for the coveted exemption if it provides advice to the parents, aunts, uncles, or siblings of a family members’ spouse or to any charitable organization that accepts funds from outside the family. And losing the exemption means the family is no longer shielded from unwanted publicity, government oversight, compliance requirements – and the attendant costs.
Definition Deadline Looming
What’s more, the clock is ticking. Family offices, who are already contemplating making major changes to their business, have until March 30, 2012 to decide if they qualify for the exemption or need to register.
Hence the identity crisis.
“This is a call to action,” said Mariann Mihailidis, managing director for the Chicago-based Family Office Exchange. “Family offices need to read the rule carefully, consult with their attorneys and decide how they want to define themselves and if they want to restructure.”
Indeed, lawyers and consultants to single-family offices say they have been flooded with calls in the wake of the SEC ruling.
“We’re hearing from family offices that are saying ‘Re-design us so we can stay a single-family office without registering with the SEC,’” said Charles Lowenhaupt, chairman and CEO of St. Louis-based Lowenhaupt Global Advisors. “The ruling is the biggest change in the history of family offices. There’s been nothing like this to date.”
Family offices who don’t qualify for the exclusion and don’t want to register with the SEC can restructure as a partially-qualifying family office by eliminating all clients not within the SEC definition of “family client” or reorganize as a regulated family private trust company, said John Duncan, principal for Chicago-based law firm Duncan Associates.
Opportunites - And Caveats - For Advisors
Other options open the door for wealth and asset managers. To comply with the SEC ruling, family offices can also outsource the chief investment officer function or hire an outsourced investment advisor on a more limited basis.
But this potential bonanza comes with important caveats.
“Outside investment advisors have to be careful to meet all their own SEC requirements under the new rule,” said Duncan, a nationally recognized expert on family office legal issues.
“In particular, they will have to now largely deal directly with the clients of a family office that is now neither exempt nor registered because that family office will no longer be allowed to make investment decisions for others or provide investment recommendations to its clients. It will only be able to pass information between the clients and their investment advisors.”
Outsourcing investment functions can become “extraordinarily complicated,” agreed Lowenhaupt, who is also an attorney and has released a white paper on the SEC ruling: “Limiting Freedom From Wealth: The Impact of New SEC Rules on Families and Single-Family Office in the United States.”
Families who want to avoid registration have to carefully review all aspects of the family office, he cautioned, and make sure all investment services are outsourced. And outside advisors have to make sure that the head of a family office, who may have been used to sitting in on every meeting, is no longer involved with investment decisions.
New Business Prospects
Despite the hassles, registered investment advisors willing to be extra-cautious do stand to pick up new business in the next six months.
In addition to work from the family offices themselves, advisors and wealth managers are well-positioned to pick up accounts from friends and former employees of family offices who no longer fit the definition of a family client under the new rule.
“It’s an opportunity for advisors who have connections with wealthy families who have a relative large family office with significant amounts of capital,” said Don Kozusko, partner with Kozusko Harris Vetter Wareh, a Washington and New York-based law firm specializing in family offices. “They will be looking to outsource investment services and will also be making referrals to those people they can no longer advise. There will be not just big amounts of money involved, but also smaller amounts.”
