[Federal Register Volume 75, Number 200 (Monday, October 18, 2010)]
[Proposed Rules]
[Pages 63753-63763]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-26086]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 275
[Release No. IA-3098; File No. S7-25-10]
RIN 3235-AK66
Family Offices
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (the ``Commission'') is
proposing a rule to define ``family offices'' that would be excluded
from the definition of an investment adviser under the Investment
Advisers Act of 1940 (``Advisers Act'') and thus would not be subject
to regulation under the Advisers Act.
DATES: Comments must be received on or before November 18, 2010.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form, http://www.sec.gov/rules/proposed.shtml; or
Send an e-mail to [email protected]. Please include
File Number S7-25-10 on the subject line; or
Use the Federal eRulemaking Portal, http://www.regulations.gov. Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number S7-25-10. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's Web
site, http://www.sec.gov/rules/proposed.shtml. Comments are also
available for Web site viewing and printing in the Commission's Public
Reference Room, 100 F Street, NE., Washington, DC 20549 on official
business days between the hours of 10 a.m. and 3 p.m. All comments
received will be posted without change; we do not edit personal
identifying information from submissions. You should submit only
information that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: Sarah ten Siethoff, Senior Special
Counsel, or Vivien Liu, Senior Counsel, at (202) 551-6787 or
[email protected], Office of Investment Adviser Regulation, Division of
Investment Management, U.S. Securities and Exchange Commission, 100 F
Street, NE., Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission is
requesting public comment on proposed rule 202(a)(11)(G)-1 [17 CFR
275.202(a)(11)(G)-1] under the Investment Advisers Act of 1940 [15
U.S.C. 80b] (the ``Advisers Act'' or ``Act'').\1\
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\1\ 15 U.S.C. 80b. Unless otherwise noted, when we refer to the
Advisers Act, or any paragraph of the Advisers Act, we are referring
to 15 U.S.C. 80b of the United States Code, at which the Advisers
Act is codified.
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Table of Contents
I. Background
[[Page 63754]]
II. Discussion
III. General Request for Comment
IV. Paperwork Reduction Act
V. Cost-Benefit Analysis
VI. Initial Regulatory Flexibility Analysis
VII. Statutory Authority
Text of Proposed Rule
I. Background
``Family offices'' are entities established by wealthy families to
manage their wealth, plan for their families' financial future, and
provide other services to family members. Single family offices
generally serve families with at least $100 million or more of
investable assets.\2\ Industry observers have estimated that there are
2,500 to 3,000 single family offices managing more than $1.2 trillion
in assets.\3\
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\2\ See John J. Bowen, Jr., In the Family Way, Financial
Planning (Aug. 1, 2004); Robert Frank, Minding the Money--`Family
Office' Chiefs Get Plied with Perks; Club Membership, Jets, The Wall
Street Journal (Sept. 7, 2007), at W2. A recent study found the
average net worth of a single family office was $517 million. See
Russ Alan Prince et al., The Family Office: Advising the Financial
Elite (2010) (``The Family Office'').
\3\ See Pamela J. Black, The Rise of the Multi-Family Office,
Financial Planning (Apr. 27, 2010). A single family office generally
provides services only to members of a single family.
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Family office services typically include managing securities
portfolios, providing personalized financial, tax, and estate planning
advice, providing accounting services, and directing charitable giving,
in each case to members of a family. Some family offices even provide
services such as travel planning or managing a family's art collection
or household staff.\4\ Family offices generally meet the definition of
``investment adviser'' under the Advisers Act, as we and our staff have
interpreted the term, because, among the variety of services provided,
family offices are in the business of providing advice about securities
for compensation.\5\
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\4\ See Raphael Amit, et al., Single Family Offices: Private
Wealth Management in the Family Context, Wharton Global Family
Alliance (Apr. 1, 2008), available at http://knowledge.wharton.upenn.edu/papers/1354.pdf (``Wharton Study''); The
Family Office, supra note 2; Angelo J. Robles, Creating a Single
Family Office for Wealth Creation and Family Legacy Sustainability,
Family Office Association, available at http://familyofficeassociation.org/dwnld/FOA_White_Paper.pdf.
\5\ 15 U.S.C. 80b-2(a)(11). See Applicability of the Investment
Advisers Act to Financial Planners, Pension Consultants, and Other
Persons Who Provide Investment Advisory Services as a Component of
Other Financial Services, Investment Advisers Act Release No. 1092
(Oct. 8, 1987) [52 FR 38400 (Oct. 16, 1987)]. There are certain
exceptions to this definition, but the typical single family office
does not meet any of these exceptions.
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We understand that many family offices have been structured to take
advantage of the exemption from registration under section 203(b)(3) of
the Advisers Act for any adviser that during the course of the
preceding 12 months had fewer than 15 clients and neither held itself
out to the public as an investment adviser nor advised any registered
investment company or business development company.\6\ Other family
offices have sought and obtained from us orders under the Advisers Act
declaring those offices not to be investment advisers within the intent
of section 202(a)(11) of the Advisers Act.\7\ We have issued more than
a dozen of these orders since the 1940s.
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\6\ 15 U.S.C. 80b-2(b)(3).
\7\ See, e.g., In the Matter of Donner Estates, Inc., Investment
Advisers Act Release No. 21 (Nov. 3, 1941); In the Matter of the
Pitcairn Company, Investment Advisers Act Release No. 52 (Mar. 2,
1949) (``Pitcairn''); In the Matter of Roosevelt & Son, Investment
Advisers Act Release No. 54 (Aug. 31, 1949); Bear Creek Inc.,
Investment Advisers Act Release Nos. 1931 (Mar. 9, 2001) (notice)
[66 FR 15150 (Mar. 15, 2001)] and 1935 (Apr. 4, 2001) (order);
Riverton Management, Inc., Investment Advisers Act Release Nos. 2459
(Dec. 9, 2005) [70 FR 74381 (Dec. 15, 2005)] and 2471 (Jan. 6, 2006)
(order).
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The Commission issued those exemptive orders pursuant to a
provision of the Advisers Act that authorizes us to exclude any person
that falls within the Advisers Act's definition of investment adviser,
but that we conclude is ``not within the intent'' of that
definition.\8\ We viewed the typical single family office as not the
sort of arrangement that Congress designed the Advisers Act to
regulate. We also were concerned that application of the Advisers Act
would intrude on the privacy of family members. Thus, each of our
orders exempted the particular family office from all of the provisions
of the Advisers Act (and not merely the registration provisions). As a
consequence, disputes among family members concerning the operation of
the family office could be resolved within the family unit or, if
necessary, through state courts under laws specifically designed to
govern family disputes, but without the involvement of the Commission.
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\8\ 15 U.S.C. 80b-2(a)(11)(G), which will be re-designated as 15
U.S.C. 80b-2(a)(11)(H) on July 21, 2010. If a person is excluded
from the definition of an investment adviser, no state can require
that person to register as an investment adviser. See 15 U.S.C. 80b-
3A(b)(1).
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Our exemptive orders have included conditions designed to
distinguish between a ``family office,'' as described above, and a
``family-run office'' that, although owned and controlled by a single
family, provides advice to a broader group of clients and much more
resembles the business model common among many smaller investment
adviser firms that are registered with the Commission or state
regulatory authorities.\9\ Accordingly, and as described in more detail
below, our exemptive orders have limited relief to those family offices
that provide advisory services only to members of a single family and
their lineal descendants, with very limited exceptions.
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\9\ There also are commercial family offices, which are for-
profit organizations that serve a much larger number of families and
typically are registered as an investment adviser with the
Commission or one or more states. See The Family Office, supra note
2. For example, GenSpring Family Offices, LLC reports on Part 1 of
its Form ADV that it provides investment advisory services to 5000
clients.
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On July 21, 2010, President Obama signed into law the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank
Act'').\10\ The Dodd-Frank Act, among other matters, will repeal the
15-client exemption contained in section 203(b)(3) of the Advisers Act,
effective July 21, 2011.\11\ The primary purpose of repealing this
exemption was to require advisers to private funds, such as hedge
funds, to register under the Advisers Act.\12\ But another potential
consequence, which Congress recognized, was that many family offices
that have relied on that exemption would be required to register under
the Advisers Act or seek an exemptive order before that section of the
Dodd-Frank Act becomes effective.
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\10\ Pub. L. 111-203, 124 Stat. 1376 (2010).
\11\ See section 403 of the Dodd-Frank Act.
\12\ See S. Conf. Rep. No. 111-176, at 38-39 (2010) (``Senate
Committee Report'').
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To prevent that consequence, section 409 of the Dodd-Frank Act
creates a new exclusion from the Advisers Act in section 202(a)(11)(G),
under which family offices, as defined by the Commission, are not
investment advisers subject to the Advisers Act.\13\ Section 409
instructs that any definition the Commission adopts should be
``consistent with the previous exemptive policy'' of the Commission and
recognize ``the range of organizational, management, and employment
structures and arrangements employed by family offices.'' \14\ We have
taken this legislative instruction into account in
[[Page 63755]]
formulating our proposed rule, as further detailed below.
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\13\ The Senate Report states that ``family offices are not
investment advisers intended to be subject to registration under the
Advisers Act'' and that ``the Advisers Act is not designed to
regulate the interactions of family members, and registration would
unnecessarily intrude on the privacy of the family involved.''
Senate Committee Report, supra note 12, at 75.
\14\ Section 409(b) of the Dodd-Frank Act. Section 409 also
includes a ``grandfathering clause'' that precludes us from
excluding certain family offices from the definition solely because
they provide investment advice to certain clients and had provided
investment advice to those clients before January 1, 2010. See
section 409(b)(3) of the Dodd-Frank Act.
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II. Discussion
We propose to adopt new rule 202(a)(11)(G)-1 under the Advisers Act
to define family offices that would be excluded from the definition of
``investment adviser'' under the Advisers Act. As a consequence, these
family offices would not be subject to any of the provisions of the
Advisers Act.
Proposed rule 202(a)(11)(G)-1 largely would codify the exemptive
orders that we have issued to family offices. Each of these exemptive
orders reflected the specific factual situation presented by the family
office applicant. Drafting a rule defining family offices, however,
requires us to turn these fact-specific exemptive orders into a rule of
general applicability. Thus, the proposed rule would not (and could
not) match the exact representations, conditions or terms contained in
every exemptive order as they varied to accommodate the particular
circumstances of each family office. For example, some of these orders
have permitted specific individuals to be treated as a member of a
family for purposes of the exemption.\15\ Moreover, the Commission's
views have changed over time as we have gained experience with family
offices, and as we have been presented with new issues. Finally, some
questions raised by this rulemaking have never been presented to us in
the context of an exemptive request, but seem appropriate to address in
a rule of general applicability.
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\15\ See, e.g., Adler Management, L.L.C., Investment Advisers
Act Release Nos. 2500 (Mar. 21, 2006) [71 FR 15498 (Mar. 28, 2006)]
(notice) and 2508 (Apr. 14, 2006) (order) (``Adler'') (permitting
one particular ``long-standing loyal family employee'' to hold a
beneficial interest in a family entity advised by the family
office).
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The proposal, which we discuss in more detail below, reflects the
Commission's current exemptive policy regarding family offices, and
thus the policy judgments that we have made in granting the more recent
orders, which Congress understood. Where terms and conditions in
exemptive applications have varied over the years, we have sought to
distill the policy rationale for the term or condition, and designed
our proposed rule to align with the general policy.
The core policy judgment that formed the basis of our exemptive
orders (and which prompted Congressional action) is the lack of need
for application of the Advisers Act to the typical single family
office.\16\ The Act was not designed to regulate the interactions of
family members in the management of their own wealth. Accordingly, most
of the conditions of the proposed rule (like our exemptive orders)
operate to restrict the structure and operation of a family office
relying on the rule to activities unlikely to involve commercial
advisory activities, while permitting traditional family office
activities involving charities, tax planning, and pooled investing.
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\16\ We note that the proposed rule would exclude directors,
partners, trustees, and employees of family offices from regulation
under the Advisers Act only when they are acting within the scope of
their position or employment.
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Finally, we note that the failure of a family office to be able to
meet the conditions of this rule would not preclude the office from
providing advisory services to family members either collectively or
individually. In such a situation, a family office could seek an
exemptive order from the Commission or, in the absence of such an
order, the family office would be subject to the Advisers Act and would
have to register unless another exemption is available. A number of
family offices currently are registered under the Advisers Act.
We request comment generally on our approach to the proposed rule
and its implementation of section 409 of the Dodd-Frank Act. Are other
approaches available that we should consider?
A. Family Office Structure and Scope of Activities
As discussed below, the proposed rule contains three general
conditions. First, it would limit the availability of the rule to
family offices that provide advice about securities only to certain
family members and key employees. Second, it would require that family
members wholly own and control the family office. Third, it would
preclude a family office from holding itself out to the public as an
investment adviser. In addition to these conditions, we have
incorporated into the rule the ``grandfathering'' provision required by
section 409 of the Dodd-Frank Act.\17\
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\17\ See supra note 14 and section II.A.4 of this release.
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1. Family Clients
We propose that excluded family offices not be permitted to have
any investment advisory clients other than ``family clients.''\18\ As
discussed in more detail below, family clients would include family
members, certain employees of the family office, charities established
and funded exclusively by family members or former family members,
trusts or estates existing for the sole benefit of family clients, and
entities wholly owned and controlled exclusively by, and operated for
the sole benefit of, family clients (with certain exceptions), and,
under certain circumstances, former family members and former
employees.
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\18\ Proposed rule 202(a)(11)(G)-1(b)(1).
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a. Family Member
We propose to define the term ``family member'' to include the
individual and his or her spouse or spousal equivalent for whose
benefit the family office was established and any of their subsequent
spouses or spousal equivalents, their parents, their lineal descendants
(including by adoption and stepchildren), and such lineal descendants'
spouses or spousal equivalents.\19\ Except as discussed below, this
definition generally corresponds to the types of clients that family
offices have advised under our exemptive orders.
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\19\ Proposed rule 202(a)(11)(G)-1(d)(3).
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Our exemptive orders issued to family offices typically have
included adopted children as family members because adopted children
generally are not treated differently as a legal matter than children
by birth.\20\ However, our exemptive orders have not always included
stepchildren as ``family members.'' \21\ Proposed rule 202(a)(11)(G)-1
would include stepchildren as family members. We recognize that
stepchildren are not treated as consistently as adopted children under
relevant tax, family, and
[[Page 63756]]
estate law.\22\ However, we are proposing including stepchildren in our
definition of a family client based on our understanding of their close
ties to the family members who would be included in the definition, and
on the fact that permitting stepchildren to be included as clients of
the family office leaves to the family members whether they wish to
include stepchildren as part of the family office clientele. Indeed,
nothing in our proposed rule would mandate that the family office
provide advice to any particular family member; it simply permits such
advice.\23\ We request comment on our proposed inclusion of
stepchildren within the meaning of the term ``family members'' for
purposes of the ``family office'' definition. Should we include
stepchildren? Are there any additional conditions that we should impose
if stepchildren are included?
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\20\ See, e.g., WLD Enterprises, Inc., Investment Advisers Act
Release Nos. 2804 (Oct. 17, 2008) [73 FR 63218 (Oct. 23, 2008)]
(notice) and 2807 (Nov. 14, 2008) (order) (``WLD''); Woodcock
Financial Management Company, LLC, Investment Advisers Act Release
Nos. 2772 (Aug. 26, 2008) [73 FR 51322 (Sept. 2, 2008)] (notice) and
2787 (Sept. 24, 2008) (order); Adler, supra note 15. For an example
of the legal treatment of adopted children, see, e.g., National
Conference of Commissioner on Uniform State Laws, Uniform Adoption
Act, (1994), at Sec. 1-104 (each adoptive parent and the adoptee
have the legal relationship of parent and child and have all the
rights and duties of that relationship). This treatment is also
reflected in Federal laws. For example, section 2(a)(51)(ii) of the
Investment Company Act of 1940 recognizes adopted children as
``lineal descendants'' for purposes of determining whether a person
is a ``qualified purchaser.''
\21\ Our exemptive orders issued to family offices in two
instances have included family offices advising stepchildren. See
WLD, supra note 20 (included two stepchildren of the patriarch's son
and their spouses and children, but required that those individuals
be provided with written disclosure describing the material terms
and effects of the exemptive order and that the office obtain
written consent from these individuals); Woodcock Financial
Management Company, LLC, Investment Advisers Act Release Nos. 2772
(Aug. 26, 2008) [73 FR 51322 (Sept. 2, 2008)] (notice) and 2787
(Sept. 24, 2008) (order) (``Woodcock'') (including matriarch's
children from a former marriage and their lineal descendants, and
the spouses of such children and descendents).
\22\ For example, under state inheritance law, stepchildren
typically are not granted the inheritance rights of genetic children
unless they are adopted. See, e.g., Mass. Gen. Laws Ann. Ch. 190B,
Sec. 1-201(5) (West 2010); Alaska Stat. Sec. 13.06.050(5) (2010);
Fla. Stat. Ann. Sec. 731.201(3) (West 2010); Haw. Rev. Stat. Sec.
560:1-201(5) (2009), (32). See also Susan N. Gary, We Are Family:
The Definition of Parent and Child for Succession Purposes, 34 ACTEC
J. 171, 172 (Winter 2008). Other states provide limited inheritance
rights to stepchildren. See, e.g., Cal. Prob. Code Sec. 6454 (West
2010) (stating that a stepchild may inherit through intestate
succession if (1) the relationship began during the child's minority
and continued throughout the joint lifetimes of the child and the
child's stepparent and (2) it is established by clear and convincing
evidence that the stepparent would have adopted the stepchild but
for a legal barrier); Conn. Gen. Stat. Ann. Sec. 45a-439(a)(1)
(West 2010) (stating that if a person dies intestate without any
surviving children, spouse, parents, siblings, or other next of kin,
then the estate is distributed to stepchildren rather than escheat
to the state); Md. Code Ann., Est. & Trusts Sec. 3-104(e) (2010)
(same). Other legal contexts have been more generous in ascribing
legal rights to stepchildren. For example, some states have
inheritance tax statutes that treat stepchildren the same as natural
or adopted children. See Wendy C. Gerzog, Families for Tax Purposes:
What About the Steps?, 42 U. Mich. J.L. Reform 805, at n.37 and
accompanying text (Summer 2009). The laws of inheritance are
beginning to ascribe more rights to stepchildren. In 2008, the
Uniform Probate Code was amended to recognize as a ``child'' for
purposes of intestate succession any child for whom a parent-child
relationship exists, regardless of whether the child's genetic
parents are married and regardless of whether the child is a genetic
child of each parent. See Uniform Probate Code Sec. Sec. 2-115 to
2-122. Some states have begun to amend their intestacy laws to
reflect these amendments. See, e.g., H.B. 09-1287, 67th Gen. Assem.,
1st Reg. Sess. (Colo. 2009); H.B. 1072, 61st Leg. Assem., Reg. Sess.
(N.D. 2009).
\23\ Thus, for example, this context differs from the intestacy
context where family is often defined narrowly because the decedent
is not alive to state whether or not he or she wishes his or her
stepchildren to inherit his or her estate.
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We also propose including ``spousal equivalents,'' using the
definition of that term currently used under our auditor independence
rules.\24\ We are not aware of any applicant that requested that
spousal equivalents be included as a permitted client of any family
office covered by our exemptive orders, and thus have never provided
such relief. However, we believe that permitting spousal equivalents to
be a family office client seems appropriate in a rule of general
applicability. We request comment on our proposed definition of spousal
equivalent.
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\24\ See 17 CFR 210.2-01(f)(9) and (13); Revision of the
Commission's Auditor Independence Requirements, Securities Act
Release No. 7919 (Nov. 21, 2000) [65 FR 76008 (Dec. 5, 2000)], at
section IV.H.8. Spousal equivalent is defined as a cohabitant
occupying a relationship generally equivalent to that of a spouse.
See proposed rule 202(a)(11)(G)-1(d)(7).
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The proposed rule also would permit a family office relying on the
exclusion to provide investment advice to parents of the family
office's founders.\25\ While the family offices that have obtained an
exemptive order from the Commission typically were managing wealth
built by an older generation--and thus the ``parents'' are typically
the ``founders,'' we understand that this may not always be the case.
For example, some entrepreneurs (such as in the technology and private
fund management sectors) have built sizeable fortunes at an early age
and may form a family office.\26\ These younger founders may wish to
include one or more of their parents as a client of the family office.
We request comment on including parents of the founders as a ``family
member'' under the proposed rule.
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\25\ Proposed rule 202(a)(11)(G)-1(d)(3).
\26\ See, e.g., Google Executives Eye Family Office, Private
Asset Management (Dec. 5, 2005), at 1; Jim Grote, Old Money vs. New
Money, Financial Advisor Magazine (May 2003).
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Our proposed definition of ``family member'' also would include
siblings of the founders of the family office, their spouses or spousal
equivalents, their lineal descendants (including by adoption and
stepchildren), and such lineal descendants' spouses or spousal
equivalents.\27\ We have issued an exemptive order to a family office
that advised siblings of one of the founders and certain of those
siblings' descendants.\28\ These individuals have close family ties to
the founders and allowing family members to choose to include these
individuals as family office clients does not appear to us to expand
the family office's clientele to such an extent that it starts to
resemble a typical commercial investment adviser. We request comment on
including siblings and their spouses and descendants in the definition
of family client.
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\27\ Proposed rule 202(a)(11)(G)-1(d)(3).
\28\ The order was to a family office that advised siblings of
one of the founders, those siblings' spouses, their children and
their spouses, and their grandchildren and spouses (the applicant
was required to give these individuals a disclosure statement
describing the material legal effects associated with a Commission
order exempting the family office from regulation under the Advisers
Act). See WLD, supra note 20.
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More generally, we request comment on our definition of family
member. Are we drawing the line too broadly or too narrowly regarding
when the clientele of a family office starts to resemble that of a
typical commercial investment adviser and not a single family? For
example, certain legally created relationships such as certain types of
guardianships may resemble the type of relationship that is included in
the definition of family member depending on the facts and
circumstances. Are there other types of family members that should be
included? Why or why not? We note that family offices would still be
able to seek a Commission exemptive order if they wanted to continue to
advise family that did not meet our proposed definition of family
member.
We are aware that some families have added other families to their
family office's clientele to achieve economies of scale and thus save
on costs.\29\ The rule would not extend to family offices serving
multiple families. We have never granted an exemptive order to a
multifamily office declaring them not to be an investment adviser and
thus including them would seem to be inconsistent with our prior
exemptive policy. Many multifamily offices more resemble a typical
commercial investment adviser appropriately subject to the Advisers
Act. Should we permit multifamily offices to operate under this
exclusion from the Advisers Act? If so, how would we distinguish
between a multi-family commercial office and an office more closely
resembling those operating under our exemptive orders (except providing
advice to multiple families)?
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\29\ See Hannah Shaw Grove & Russ Alan Prince, E Pluribus Unum,
Registered Rep (May 1, 2004). These multi-family offices generally
serve families with a lesser average net worth. See The Family
Office, supra note 2 (finding that the average net worth for a
multi-family office client to be $116 million).
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b. Involuntary Transfers
We recognize that family offices may encounter situations in which
assets under management are transferred involuntarily. We note that one
implication of the proposed rule would be that a family office could
continue to provide advice without becoming an investment adviser under
the Advisers Act to a person that receives assets in an involuntary
transfer only if the involuntary transaction is to a person that is a
family client. For example, if
[[Page 63757]]
a family member in his will left assets in a family office-advised
private fund to a charity that did not qualify as a family client,
generally after that family member died the family office could not
continue to provide investment advice with respect to those assets and
still rely on rule 202(a)(11)(G)-1 to be excluded from the definition
of an investment adviser. The proposed rule would permit the family
office to continue to advise such a client without violating the terms
of the exclusion for four months following the transfer of assets
resulting from the involuntary event, which should allow that family
office to orderly transition that client's assets to another investment
adviser, seek exemptive relief, or otherwise restructure its activities
to comply with the Advisers Act.\30\
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\30\ Proposed rule 202(a)(11)(G)-1(b)(1).
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We believe that this treatment of involuntary transfers is
appropriate because after such a bequest, the office would no longer be
providing advice solely to members of a single family, and after
several such bequests the office would cease to operate as a family
office. Indeed, we have never issued an exemptive order to a family
office permitting involuntary transfers to non-family members. However,
we recognize that the Commission in some contexts has treated
involuntary transfers in this manner and in other contexts permitted
involuntary transfers outside the family.\31\ We request comment on our
proposed approach regarding involuntary transfers. Should we permit
family clients to transfer assets advised by the family office to non-
family clients if there is a death or other involuntary event without
jeopardizing the ability of the family office to rely on the exclusion
under proposed rule 202(a)(11)(G)-1? If so, under what conditions and
to what types of transferees? How would we distinguish between a
typical commercial adviser serving both related and unrelated clients
from a family office resembling those operating under our prior
exemptive orders? Should we allow a different period of time or
transition mechanism to transfer assets that a non-family client
receives in an involuntary transfer to another investment adviser?
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\31\ For example, under our rules addressing the exclusion of
private funds from the definition of an investment company, the
Commission has treated an involuntary transfer of securities as if
the transfer had not occurred, consistent with the direction from
Congress in the Investment Company Act. See 15 U.S.C. 80a-3(c)(1)(B)
15 U.S.C. 80a-3(c)(7)(A); 17 CFR 270.3c-6. However, under our rules
relating to the registration of securities pursuant to certain
compensatory benefit plans, we have only permitted involuntary
transfers to family members without jeopardizing the ability of the
person to continue to rely on the exemptive provision. See 17 CFR
230.701 (exempting offers and sales of securities under a written
compensatory benefit plan or written compensation contract for the
participation of employees, directors, general partners, trustees,
officers, or consultants and advisors, and their family members who
acquire such securities from such persons through gifts or domestic
relations orders). See also General Instruction A.1(a)(5) to Form S-
8 (The form also is available for the exercise of employee benefit
plan options and the subsequent resale of the underlying securities
by an employee's family member who has acquired the options from the
employee through a gift or a domestic relations order.);
Registration of Securities on Form S-8, Securities Act Release No.
7646 (Feb. 26, 1999) [64 FR 11103 (Mar. 8, 1999)], at section
III.A.2 (explicitly rejecting expanding the availability of the
abbreviated disclosure in Form S-8 for the exercise of employee
benefit plan options transferred by gift to charities or to other
``unrelated persons who are the object of the employee's
generosity'' and stating that ``[w]hile we seek to facilitate
employees' estate planning through the amendments we adopt today, we
must keep in mind that investor protection is our primary
objective'' and to ``permit entities that are not controlled by, or
for the primary benefit of, an employee's family members to exercise
options on Form S-8 would suggest that the abbreviated Form S-8
disclosure is adequate for the offer and sale of securities to non-
employees generally. As discussed above, we remain firmly persuaded
of the contrary view.'').
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c. Former Family Members
None of our exemptive orders have permitted former family members
to receive investment advice from an exempt family office.\32\ However,
we recognize that divorces and other events may occur in some families
covered by the rule and that addressing in our proposed rule the effect
of these circumstances on the family office would provide clarity to
family offices affected by such a legal separation from the family.
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\32\ By including in the definition of ``founders'' any
subsequent spouse of a founder, our proposed rule would address the
situation in which the founders divorce and one or both of the
founders subsequently remarries. See proposed rule 202(a)(11)(G)-
1(d)(5). Again, we are not aware of any applicant for an exemptive
order having requested that the order cover this situation, but in
formulating a rule of general applicability, we thought it important
to address the impact of this situation on the family office's
exclusion under the Advisers Act.
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We propose permitting former family members, i.e., former spouses,
spousal equivalents and stepchildren, to retain any investments held
through the family office at the time they became a former family
member.\33\ However, we propose to limit former family members from
making any new investments through the family office.\34\ Our approach
is designed to prevent such a separation from resulting in harmful
investment or tax consequences, while also recognizing that such
persons are no longer members of the family controlling the office, and
thus would not be subject to the protections we assume accompany
membership in a family. We request comment on this approach. Should we
exclude former family members? Are there other approaches to treating
such persons that we should consider?
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\33\ Proposed rule 202(a)(11)(G)-1(d)(2)(vi), and (d)(4).
\34\ The proposed rule would permit the family office to provide
investment advice with respect to additional investments that the
former spouse or spousal equivalent was contractually obligated to
make, and that relate to a family-office advised investment
existing, prior to the time the person became a former spouse or
spousal equivalent (e.g., if the individual has a previously
existing capital commitment to a private fund advised by the family
office). See proposed rule 202(a)(11)(G)-1(d)(2)(vi).
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d. Family Trusts, Charitable Organizations, and Other Family Entities
We also propose to treat as a ``family client'' any charitable
foundation, charitable organization, or charitable trust established
and funded exclusively by one or more family members \35\ and any trust
or estate existing for the sole benefit of one or more family
clients.\36\ Similarly, we would also treat as a family client any
company,\37\ including a pooled investment vehicle, that is wholly
owned and controlled, directly or indirectly, by one or more family
clients and operated for the sole benefit of family clients.\38\ We
generally have included these types of companies and organizations when
owned and controlled by family members to be treated as permitted
clients of the family office under our exemptive orders.\39\ Including
them should allow the family office to structure its activities through
typical investment structures. We request comment on this aspect of our
proposal.
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\35\ Proposed rule 202(a)(11)(G)-1(d)(2)(iii).
\36\ Proposed rule 202(a)(11)(G)-1(d)(2)(iv).
\37\ ``Company'' is defined in section 202(a)(5) of the Advisers
Act to mean ``a corporation, a partnership, an association, a joint-
stock company, a trust, or any organized group of persons, whether
incorporated or not; or any receiver, trustee in a case under title
11, or similar official, or any liquidating agent for any of the
foregoing, in his capacity as such.''
\38\ Proposed rule 202(a)(11)(G)-1(d)(2)(v). Under proposed rule
202(a)(11)(G)-1(d)(1), control would be defined as the power to
exercise a controlling influence over the management or policies of
an entity, unless such power is solely the result of being an
officer of such entity. If any of these companies are pooled
investment vehicles, they must be exempt from registration as an
investment company under the Investment Company Act of 1940 because
the Advisers Act requires that an adviser to a registered investment
company must register. See 15 U.S.C. 80b-3a(a)(1)(B).
\39\ See, e.g., Woodcock, supra note 21; Kamilche Company,
Investment Advisers Act Release Nos. 1958 (Jul. 31, 2001) [66 FR
41063 (Aug. 6, 2001)] (notice) and 1970 (Aug. 27, 2001) (order).
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[[Page 63758]]
e. Key Employees
We also are proposing to treat as family members certain key
employees of the family office so that they may receive investment
advice from and participate in investment opportunities provided by the
family office. Such persons have been treated like family members in
some of our exemptive orders.\40\ Permitting participation by key
employees allows such family offices to incentivize key employees to
take a job with the family office and to create positive investment
results at the family office under terms that could be available to
them as employees of other types of money management firms. It is our
understanding that in some cases family offices may need to provide
such incentives to attract highly skilled investment professionals who
may not otherwise be attracted to work at a family office.\41\
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\40\ See, e.g., WLD, supra note 20 (family office provided
investment advice to several executives of the family business and
their trusts); Gates Capital Partners, LLC/Bear Creek, Inc.,
Investment Advisers Act Release Nos. 2590 (Feb. 16, 2007) [72 FR
8405 (Feb. 26, 2007)] (notice) and 2599 (Mar. 20, 2007) (order) (two
pooled investment vehicles advised by the family office had non-
voting interests owned by certain senior employees of the family
office); Adler, supra note 15 (one long-standing employee held
interest in one family office advised entity). These key employees
typically either had their investments frozen or were permitted to
continue their side-by-side investments through the family office
but upon termination of employment were limited to investments at
the time of termination along with reinvestment of accretions or
distributions on the investment.
\41\ See e.g., Robert Frank, Minding the Money--`Family Office'
Chiefs Get Plied with Perks; Club Membership, Jets. The Wall Street
Journal, at W2 (Sept. 7, 2007) (``a growing number of wealthy
families are dangling the biggest perk of all: allowing their family
office manager to become a ``participant,'' investing his or her own
funds along with the family money in big deals''). But see Thomas
Coyle, Family Offices Mostly unscathed by Overhaul, Dow Jones News
Service (Jul. 16, 2010) (``family office recruiters don't think co-
investment plays a big role in attracting family office managers'').
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The Dodd-Frank Act acknowledges the Commission's exemptive policy
in this area by requiring that in defining a ``family office'' we
``recognize the range of organizational, management, and employment
structures and arrangements employed by family offices'' in defining
excluded family offices.\42\ The Senate committee report explained that
some family offices have non-family member directors, officers, and
employees that may co-invest with family members, enabling them to
share in the profits of investments that they oversee and better
aligning the interests of such persons with those of the family members
served by the family office.\43\ The report states that it expected
that ``such arrangements would not automatically exclude a family
office from the definition.'' \44\
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\42\ Section 409(b)(2) of the Dodd-Frank Act.
\43\ Senate Committee Report, supra note 12, at 76.
\44\ Id.
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The proposed rule would permit the family office to provide
investment advice to any natural person (including persons who hold
joint and community property with their spouse) who is (i) an executive
officer, director, trustee, general partner, or person serving a
similar capacity of the family office, or (ii) any other employee of
the family office (other than an employee performing solely 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 similar functions or duties for or on behalf of
another company, for at least twelve months.\45\
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\45\ Proposed rule 202(a)(11)(G)-1(d)(6). The proposed rule also
would permit the family office to provide investment advice to
trusts created for the sole benefit of family clients (which could
include these key employees), and to other entities wholly owned and
controlled by and operated for the sole benefit of family clients.
Proposed rule 202(a)(11)(G)-1(d)(2)(iv)-(v).
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We believe that this standard would limit employees who participate
without the protections of the Advisers Act (or family membership) to
those employees that are likely to be in a position or have a level of
knowledge and experience in financial matters sufficient to be able to
evaluate the risks and take steps to protect themselves. This
definition of key employee is based on the ``knowledgeable employee
standard'' currently contained in Advisers Act rule 205-3(d)(iii),
which specifies the types of clients to whom the adviser may charge
performance fees.\46\ We adopted the knowledgeable employee exception
in the performance fee rule based on a similar policy conclusion that
these types of employees are likely to be sophisticated financially and
not need the protections of the Advisers Act's restrictions on
performance fees.\47\
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\46\ The knowledgeable employee standard in Advisers Act rule
205-3 was itself based on the similar standard under the Investment
Company Act of 1940 for knowledgeable employees of private funds
that are exempt from registration under the Investment Company Act
through section 3(c)(1) or 3(c)(7) of the Investment Company Act.
See rule 3c-5 under the Investment Company Act [17 CFR 270.3c-5];
Exemption To Allow Investment Advisers To Charge Fees Based upon a
Share of Capital Gains upon or Capital Appreciation of a Client's
Account, Investment Advisers Act Release No. IA-1731 (Jul. 15, 1998)
[63 FR 39022 (Jul. 21, 1998)], at nn.24-28 and accompanying text.
\47\ See Exemption To Allow Investment Advisers To Charge Fees
Based upon a Share of Capital Gains upon or Capital Appreciation of
a Client's Account, Investment Advisers Act Release No. IA-1731
(Jul. 15, 1998) [63 FR 39022 (Jul. 21, 1998)], at nn.24-28 and
accompanying text.
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Similar to our treatment of family members under the proposed rule,
key employees would be able to structure their investments through
trusts and other entities, subject to the conditions relating to
control and ownership described earlier in this Release.\48\ Upon the
end of key employees' employment by the family office, key employees
(including their trusts and controlled entities) would not be permitted
to make additional investments through the family office.\49\ Similar
to our treatment of former spouses, spousal equivalents, and
stepchildren, our proposed rule would not require former key employees
to liquidate or transfer investments held through the family office at
the time of the end of their employment, however, to avoid imposing
possible adverse tax or investment consequences that might otherwise
result.
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\48\ See section II.A.1.d of this Release. See also WLD, supra
note 20 (permitting the family office to advise key employee
trusts).
\49\ Proposed rule 202(a)(11)(G)-1(d)(2)(vii).
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We request comment on our proposed treatment of investments by
employees of the family office. Should we permit key employees to
receive investment advice through the family office? Do family offices
rely on allowing co-investment to attract talented investment
professionals to work at the family office? Should the definition of
key employee be based on the knowledgeable employee standard in rule
205-3 under the Advisers Act? Are there restrictions that we should
consider imposing as a condition to such investment to help protect
non-family members investing through the family office? Should we allow
former key employees to retain their investments through the family
office at the time of termination? Are any of our conditions too
restrictive? For example, should we modify or eliminate the 12-month
experience requirement for key employees? If so, how and why? Are there
other types of individuals or entities that should be permitted to
invest through the family office without jeopardizing that family
office's exclusion under the Advisers Act?
More broadly, we request comment on our definition of who is
considered a ``family client.'' We have not included every type of
individual or entity that has been included in a prior exemptive order
based on specific facts and circumstances. We do not believe we could
have taken such an approach in a rule of general applicability and we
note that family offices would remain free to seek a Commission
exemptive order to advise an individual or entity
[[Page 63759]]
that does not meet our proposed family client definition. However, we
request comment on our approach. Are there other individuals or
entities that should be included? Under our proposed rule, the family
office could not provide investment advice to a person that may have a
long employment relationship with the family but does not qualify as a
``key employee.'' Are there other types of individuals that commonly
have close ties to a family that should be included as a family client?
We note that as a family office extends its provision of investment
advice beyond family members, it increasingly resembles a more typical
commercial investment advisory business, and not a family managing its
own wealth.
2. Ownership and Control
We propose that to operate under the proposed exclusion from the
Advisers Act the family office be wholly owned and controlled, either
directly or indirectly, by family members.\50\ This condition generally
is consistent with our exemptive orders \51\ and assures that the
family is in a position to protect its own interests and thus is less
likely to need the protection of the Federal securities laws.
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\50\ Proposed rule 202(a)(11)(G)-1(b)(2).
\51\ See, e.g., WLD, supra note 20 (requiring that a majority of
the board of directors of the family office be comprised of family
members and that the family office be wholly owned by family
members); Slick Enterprises, Inc., Investment Advisers Act Release
Nos. 2736 (May 22, 2008) [73 FR 30984 (May 29, 2008)] (notice) and
2745 (June 20, 2008) (order) (same) (``Slick'').
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This condition also helps distinguish family offices from family-
run offices that may provide advice to other people, as well as other
families, and operates as a more typical commercial investment adviser.
Most family offices that have obtained an exemptive order from the
Commission under the Advisers Act have represented that they did not
operate for the purpose of generating a profit and charged fees
designed to just cover their costs.\52\ This feature helped distinguish
these family offices from the family-run investment advisory businesses
that the Advisers Act appropriately regulates. Requiring that the
family office be wholly owned by family members alleviates any concern
that we may otherwise have about the profit structure of the family
office, because any profits generated by the family office from
managing family clients' assets only accrue to family members.
Accordingly, we are not proposing a specific condition regarding
whether the family office generates a profit.
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\52\ See, e.g., WLD, supra note 20; Adler, supra note 15;
Parkland Management Company, L.L.C., Investment Advisers Act Release
Nos. 2362 (Feb. 24, 2005) [70 FR 10155 (Mar. 2, 2005)] (notice) and
2369 (Mar. 22, 2005) (order); Longview Management Group LLC,
Investment Advisers Act Release Nos. 2008 (Jan. 3, 2002) [67 FR 1251
(Jan. 9, 2002)] (notice) and 2013 (Feb. 7, 2002) (order).
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We request comment on the condition that the family office be
wholly owned and controlled by family members. Are there reasons that
we should not require that the family office be wholly owned and
controlled by family members? Should some minor ownership stake of non-
family members be permitted? \53\ If we permitted non-family members to
own a minor ownership stake in the family office, what other
protections should we impose to ensure that the family office did not
operate as a more typical commercial investment adviser? Are there
other restrictions on ownership and control of the family office that
we should impose consistent with our policy goals? Should we also
require that the family office be operated without the intent of
generating a profit or only charge fees designed to cover its costs and
the compensation of its employees?
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\53\ In one case we granted an exemptive order to a family
office in which four churches owned a small interest in the family
office. See Pitcairn, supra note 7. In one other case we granted an
exemptive order to a family office owned by a trust in which half of
the trustees were independent and half of the trustees were family
members. See Moreland Management Company, Investment Advisers Act
Release Nos. 1700 (Feb. 12, 1998) [63 FR 8710 (Feb. 20, 1998)]
(notice) and 1706 (Mar. 10, 1998) (order).
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3. Holding Out
Consistent with our exemptive orders,\54\ we propose to prohibit a
family office relying on the rule from holding itself out to the public
as an investment adviser.\55\ Holding itself out to the public as an
investment adviser suggests that the family office is seeking to enter
into typical advisory relationships with non-family clients, and thus
is inconsistent with the basis on which we have provided exemptive
orders and this proposed rule.\56\ We request comment on this proposed
condition. Are there circumstances where a family office holding itself
out to the general public as an investment adviser should nevertheless
be excluded from the protections afforded to the investing public under
the Advisers Act?
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\54\ See, e.g., WLD, supra note 20; Woodcock, supra note 21;
Slick, supra note 51.
\55\ Proposed rule 202(a)(11)(G)-1(b)(3).
\56\ We note that the exemption from registration under section
202(b)(3) of the Advisers Act is not available to a person that
holds himself out as an investment adviser. In addition, our staff
has stated that a person that holds himself out as an investment
adviser or as one who provides investment advice satisfies the ``in
the business'' element of being an investment adviser under the
Advisers Act. See Applicability of the Investment Advisers Act to
Financial Planners, Pension Consultants, and Other Persons Who
Provide Investment Advisory Services as a Component of Other
Financial Services, Investment Advisers Act Release No. 1092 (Oct.
8, 1987) [52 FR 38400 (Oct. 16, 1987)].
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4. Grandfathering Provisions
The Dodd-Frank Act prohibits us from excluding from our definition
of family office persons not registered or required to be registered on
January 1, 2010 that would meet all of the required conditions under
rule 202(a)(11)(G)-1 but for their provision of investment advice to
certain clients specified in section 409(b)(3) of the Dodd-Frank
Act.\57\ We have incorporated this required grandfathering into
paragraph (c) of our proposed rule.\58\
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\57\ See section 409(b)(3) and (c) of the Dodd-Frank Act. The
family office must have been providing investment advice to such
clients before January 1, 2010. The grandfathered clients are
natural persons who, at the time of their investment, are officers,
directors, or employees of the family office, and had invested with
the family office before January 1, 2010. These clients must be
accredited investors under Regulation D of the Securities Act of
1933. The other grandfathered clients are investment advisers
registered under the Advisers Act that in turn provide investment
advice and identify investment opportunities to the family office
and invest in such transactions on substantially the same terms as
the family office invests, but does not invest in other funds
advised by the family office and whose assets as to which the family
office directly or indirectly provides investment advice represent,
in the aggregate, not more than 5% of the value of the total assets
as to which the family office provides investment advice. See
proposed rule 202(a)(11)(G)-1(c).
\58\ A family office that will only qualify for the exclusion
under section 202(a)(11)(G) of the Advisers Act, as amended by the
Dodd-Frank Act, because of section 409(b)(3) of the Dodd-Frank Act
will still be subject to paragraphs (1), (2) and (4) of section 206
of the Advisers Act. See section 409(c) of the Dodd-Frank Act.
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B. Effect of Rule on Previously Issued Exemptive Orders
As discussed above, the Commission has issued orders under section
202(a)(11)(G) of the Advisers Act to certain family offices declaring
them and their employees acting within the scope of their employment to
not be investment advisers within the intent of the Act. In some areas
these exemptive orders may be slightly broader than the rule we are
proposing today, and in other areas they may be narrower.
We are not proposing to rescind the orders we have issued to family
offices because we do not believe that the policy behind the previously
issued orders differs substantially from that of our proposal. Further,
single family offices do not compete with one another and thus there is
no need to rescind exemptive orders to create a ``level playing
field.'' Family offices currently
[[Page 63760]]
operating under these orders could continue to rely on those orders or,
if they meet the conditions of proposed rule 202(a)(11)(G)-1, they
could rely on the rule. We request comment on whether we should rescind
previous orders granted to family offices under section 202(a)(11)(G)
of the Advisers Act. Should we rescind the very early orders that did
not impose all of the same conditions as more recent orders?
III. General Request for Comment
The Commission requests comment on the rule proposed in this
Release, suggestions for additional changes to the existing rules and
comment on other matters that might have an effect on the proposals
contained in this Release. Commenters should provide empirical data to
support their views.
IV. Paperwork Reduction Act
Proposed rule 202(a)(11)(G)-1 does not contain a ``collection of
information'' requirement within the meaning of the Paperwork Reduction
Act of 1995.\59\ Accordingly, the Paperwork Reduction Act is not
applicable.
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\59\ 44 U.S.C. 3501 et seq.
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V. Cost-Benefit Analysis
We have identified certain costs and benefits of the proposed new
rule, and we request comment on all aspects of this cost benefit
analysis, including identification and assessment of any costs and
benefits not discussed in this analysis. We seek comment and data on
the value of the benefits identified. We also welcome comments on the
accuracy of the cost estimates in this analysis, and request that
commenters provide data that may be relevant to these cost estimates.
In addition, we seek estimates and views regarding these costs and
benefits for particular family offices as well as any other costs or
benefits that may result from the adoption of the proposed new rule.
In proposing this rule, we are responding to the Dodd-Frank Act's
repeal of section 203(b)(3) of the Advisers Act and proposing a new
exclusion for a ``family office,'' which Congress anticipated we would
define.\60\ Proposed rule 202(a)(11)(G)-1 would exclude from regulation
under the Advisers Act family offices that meet the qualifications and
conditions contained in the proposed rule. Among other matters, to
qualify as an excluded family office, the family office generally must
have no non-family clients, must be wholly owned and controlled by
family members, and must not hold itself out to the public as an
investment adviser.
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\60\ See section 409 of the Dodd-Frank Act.
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A. Benefits
As discussed earlier in this Release, we expect that proposed rule
202(a)(11)(G)-1 would yield several important benefits. First, the
proposed rule would result in several benefits for excluded family
offices that do not already have an exemptive order. They would not be
subject to the costs of registering with the Commission as an
investment adviser and its associated compliance costs (or if they were
previously registered, they would benefit from the reduced regulatory
costs after de-registering in reliance on the exclusion). These reduced
regulatory costs should result in direct cost savings to these family
offices, and thus to their family clients. Excluded family offices
would be able to maintain greater privacy because they would not have
to make the public filings with the Commission that they would
otherwise have to make as a registered investment adviser.
The proposed rule also would benefit the Commission and family
offices that meet the conditions of the proposed rule and their clients
by eliminating the costs and inefficiencies of seeking (and
considering) individual exemptive orders. As discussed above, family
offices that did not qualify for the exemption from registration
contained in section 203(b)(3) of the Advisers Act often applied to the
Commission for exemptive relief from the Advisers Act. Following the
repeal of the exemption contained in section 203(b)(3), we would expect
a much greater number of family offices to otherwise apply for
exemptive relief absent our rule proposal.\61\ We estimate that a
typical family office (and thus indirectly their family clients) would
incur legal fees of $200,000 on average to engage in the exemptive
order application process, including preparation and revision of an
application and consultations with Commission staff.\62\ The proposed
rule would benefit qualifying family offices and their family clients
by eliminating the costs of applying to the Commission for an exemptive
order to avoid registration and the associated compliance burdens. It
also would benefit excluded family offices and their family clients by
eliminating the uncertainty that they might not obtain such an order.
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\61\ See supra note 3 and accompanying text for industry
estimates of the number of single family offices.
\62\ This estimate is based on our understanding of typical
outside legal fees for past applications.
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The proposed rule also would benefit the Commission by freeing
staff resources from reviewing and processing family office exemptive
applications that would result from the repeal of section 203(b)(3) of
the Advisers Act in many cases where the staff would likely recommend
to the Commission that exclusion from regulation under the Advisers Act
was appropriate and in the public interest, allowing the staff to
target its work more efficiently, and thus would indirectly benefit
investors.
We seek comment on whether the elimination of these costs would
result in additional benefits to family offices or their clients.
B. Costs
We recognize that there are costs that could result if we adopted
our proposed rule. We do not expect that the proposed rule would impose
any significant costs on family offices currently operating under a
Commission exemptive order. We are permitting these family offices to
continue to rely on their exemptive orders and thus would expect them
to do so if the costs to do so were lower than complying with the
proposed rule. We expect that most of these family offices could
satisfy all the conditions of the rule without changing their structure
or operations. However, these family offices may incur one-time
``learning costs'' in determining the differences between their orders
and the rule. We expect that such costs would be no more than $5,000 on
average for a family office if it hires an external consulting firm or
law firm to assist in determining the differences.\63\ There are 13
family offices that have obtained exemptive orders. Accordingly, we
estimate that these family offices collectively would incur outside
consulting or legal expenses of $65,000 to discern the differences
between their orders and the rule.
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\63\ We expect that a family office would need no more than 10
hours of consulting or legal advice to learn the differences between
its order and the rule. We estimate that this advice would cost the
family office $500 per hour based on our understanding of the rates
typically charged by outside consulting or law firms.
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As discussed above, there are a number of family offices that
currently are not registered as an investment adviser in reliance on
the exemption from registration in section 203(b)(3) of the Advisers
Act. The proposed rule would not impose any costs on those advisers
because they currently are exempt from registration and thus would have
no reason to consider whether they would rather rely on the proposed
rule to relieve them of the
[[Page 63761]]
burdens associated with being a registered investment adviser. After
July 21, 2010, section 203(b)(3) of the Advisers Act will be repealed
and as a result, some of these family offices would be subject to the
costs and burdens of registration under the Advisers Act. However,
these costs are a consequence of section 403 of the Dodd-Frank Act
repealing the section 203(b)(3) exemption, and not this rulemaking.
Accordingly, we do not attribute these costs to this rulemaking and
thus are not considering them.
We recognize that some family offices may decide to restructure
their business to meet the conditions imposed by proposed rule
202(a)(11)(G)-1 so that they would avoid the costs and burdens of
registration in reliance on our proposed rule. Some family offices may
need to reorganize the ownership or control structure of the family
office in order to meet the family office definition under the proposed
rule. We estimate that this type of reorganization could be
accomplished without significant costs being imposed on the family
office because we estimate that most family offices are wholly owned
and those that are not only have a small number of non-family members
with ownership interests. Other family offices may have to terminate
providing investment advice to certain persons because they would not
meet the definition of a ``family client,'' which may require these
individuals to divest interests in pooled investment vehicles and other
entities advised by the family office. The costs of any such
restructuring would be highly dependent on the nature and extent of
investment of these non-qualifying clients through the family office,
which we understand may vary significantly from family office to family
office.
Finally, if there were any family offices that previously
registered with the Commission, but now may de-register in reliance on
the new family office exclusion in the Advisers Act, the proposed rule
may have competitive effects on investment advisers that may compete
with the family office for the provision of investment management
services to family clients since these third party investment advisers
would bear the regulatory costs associated with compliance with the
Advisers Act or state investment adviser regulatory requirements. We do
not expect that the proposed rule would impact capital formation.
We request comment on this analysis. Would family offices that
currently rely on an order bear lower costs if they rely on the
proposed rule? What amount and types of costs will these family offices
bear as a result of the proposed rule? How many family offices are
likely to restructure and in what ways? At what cost? What competitive
impacts may result if registered family offices de-register if the
proposed rule is adopted?
C. Request for Comment
The Commission requests comments on all aspects of the cost-benefit
analysis, including the accuracy of the potential costs and benefits
identified and assessed in this Release, as well as any other costs or
benefits that may result from the proposals. We encourage commenters to
identify, discuss, analyze, and supply relevant data regarding these or
additional costs and benefits. For purposes of the Small Business
Regulatory Enforcement Fairness Act of 1996,\64\ the Commission also
requests information regarding the potential annual effect of the
proposals on the U.S. economy. Commenters are requested to provide
empirical data to support their views.
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\64\ Pub. L. 104-121, Title II, 110 Stat. 857 (1996) (codified
in various sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C.
601).
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VI. Initial Regulatory Flexibility Analysis
The Commission has prepared the following Initial Regulatory
Flexibility Analysis (``IRFA'') regarding proposed rule 202(a)(11)(G)-1
in accordance with section 3(a) of the Regulatory Flexibility Act.\65\
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\65\ 5 U.S.C. 603(a).
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A. Reasons for Proposed Action
We are proposing rule 202(a)(11)(G)-1 defining family offices
excluded from regulation under the Advisers Act because we are required
to do so under Section 409 of the Dodd-Frank Act.
B. Objectives and Legal Basis
As described more fully in Sections I and II of this Release, the
general objective of proposed rule 202(a)(11)(G)-1 is to define a
family office consistent with prior Commission exemptive policy
consistent with the Dodd-Frank Act. The Commission is proposing rule
202(a)(11)(G)-1 pursuant to our authority set forth in section
202(a)(11)(G) of the Advisers Act [15 U.S.C. 80b-2(a)(11)(G)].
C. Small Entities Subject to the Rule
Under Commission rules, for the purposes of the Advisers Act and
the Regulatory Flexibility Act, an investment adviser generally is a
small entity if it: (i) Has assets under management having a total
value of less than $25 million; (ii) did not have total assets of $5
million or more on the last day of its most recent fiscal year; and
(iii) does not control, is not controlled by, and is not under common
control with another investment adviser that has assets under
management of $25 million or more, or any person (other than a natural
person) that had $5 million or more on the last day of its most recent
fiscal year.\66\
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\66\ 17 CFR 275.0-7(a).
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We do not have data and are not aware of any databases that compile
information regarding how many family offices would be a small entity
under this definition, but since family offices only are established
for the very wealthy and given the statistics noted earlier showing
that they generally serve families with at least $100 million or more
of investable assets and have an average net worth of $517 million, we
believe it is unlikely that any family offices would be small
entities.\67\
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\67\ See supra note 2 and accompanying text. See also The Family
Office, supra note 2 (finding investable assets of single family
offices surveyed ranged from $197 million to $843 million); Family
Wealth Alliance, Single-Family Office Study Executive Summary,
available at http://www.fwalliance.com/store/2ndannualsinglefamilystudy.html (finding assets under management of
surveyed single family offices ranged from $51 million to $2.1
billion); Wharton Study, supra note 4, at 4 (stating that surveyed
single family offices had at least $100 million in investable
assets).
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D. Reporting, Recordkeeping, and Other Compliance Requirements
Proposed rule 202(a)(11)(G)-1 would impose no reporting,
recordkeeping or other compliance requirements.
E. Duplicative, Overlapping, or Conflicting Federal Rules
The Commission has not identified any Federal rules that duplicate,
overlap, or conflict with the proposed rule.
F. Significant Alternatives
The Regulatory Flexibility Act directs the Commission to consider
significant alternatives that would accomplish the stated objective,
while minimizing any significant impact on small entities. In
connection with the proposed rules and amendments, the Commission
considered the following alternatives: (i) The establishment of
differing compliance or reporting requirements or timetables that take
into account the resources available to small entities; (ii) the
clarification, consolidation, or simplification of compliance and
reporting requirements under the rule for small entities; (iii) the use
of performance rather than design standards; and (iv) an exemption from
coverage of the rule, or any part thereof, for small entities.
[[Page 63762]]
Proposed rule 202(a)(11)(G)-1 is exemptive and compliance with the
rule would be voluntary. We therefore do not believe that different or
simplified compliance, timetable, or reporting requirements, or an
exemption from coverage of the proposed rule for small entities would
be appropriate. The conditions in the proposed rule are designed to
ensure that family offices operating under the rule would only impact
the family itself and not the general public and, accordingly, the
protections of the Advisers Act are not warranted. Reducing these
conditions for smaller family offices would be inconsistent with the
policy underlying the exclusion and would harm investor protection.
Our prior exemptive orders have not made any differentiation based
on the size of the family office. In addition, as discussed above, we
expect that very few, if any, family offices are small entities. The
Commission also believes that proposed rule 202(a)(11)(G)-1 would
decrease burdens on small entities by making it unnecessary for them to
seek an exemptive order from the Commission to operate without
registration under the Advisers Act. As a result, we do not anticipate
that the potential impact of the proposed rule on small entities would
be significant.
The proposed rule specifies broad conditions with which a family
office must comply to rely on the exclusion; the proposed rule leaves
to each family office how to structure its specific operations to meet
these conditions. The proposed rule thus already incorporates
performance rather than design standards. For these reasons,
alternatives to the proposed rule appear unnecessary and in any event
are unlikely to minimize any impact that the proposed rule might have
on small entities.
G. Solicitation of Comments
We encourage written comments on matters discussed in this IRFA. In
particular, the Commission seeks comment on:
The number of small entities that would be affected by the
proposed rule; and
Whether the effect of the proposed rule on small entities
would be economically significant.
Commenters are asked to describe the nature of any effect and
provide empirical data supporting the extent of the effect.
VII. Statutory Authority
We are proposing rule 202(a)(11)(G)-1 [17 CFR 275.202(a)(11)(G)-1]
pursuant to our authority set forth in section 202(a)(11)(G) of the
Advisers Act [15 U.S.C. 80b-2(a)(11)(G)].
List of Subjects in 17 CFR Part 275
Reporting and recordkeeping requirements, Securities.
Text of Proposed Rule
For the reasons set out in the preamble, Title 17, Chapter II of
the Code of Federal Regulations is proposed to be amended as follows.
PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
1. The authority citation for Part 275 continues to read in part as
follows:
Authority: 15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(17), 80b-3, 80b-
4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise noted.
* * * * *
2. Section 275.202(a)(11)(G)-1 is added to read as follows:
Sec. 275.202(a)(11)(G)-1 Family offices.
(a) Exclusion. A family office, as defined in this section, shall
not be considered to be an investment adviser for purpose of the Act.
(b) Family office. A family office is a company (including its
directors, partners, trustees, and employees acting within the scope of
their position or employment) that:
(1) Has no clients other than family clients; provided that if a
person that is not a family client becomes a client of the family
office as a result of the death of a family member or key employee or
other involuntary transfer from a family member or key employee, that
person shall be deemed to be a family client for purposes of this Sec.
275.202(a)(11)(G)-1 for four months following the transfer of assets
resulting from the involuntary event;
(2) Is wholly owned and controlled (directly or indirectly) by
family members; and
(3) Does not hold itself out to the public as an investment
adviser.
(c) Grandfathering. A family office as defined in paragraph (a) of
this section shall not exclude any person, who was not registered or
required to be registered under the Act on January 1, 2010, solely
because such person provides investment advice to, and was engaged
before January 1, 2010 in providing investment advice to:
(1) Natural persons who, at the time of their applicable
investment, are officers, directors, or employees of the family office
who have invested with the family office before January 1, 2010 and are
accredited investors, as defined in Regulation D under the Securities
Act of 1933;
(2) Any company owned exclusively and controlled by one or more
family members; or
(3) Any investment adviser registered under the Act that provides
investment advice to the family office and who identifies investment
opportunities to the family office, and invests in such transactions on
substantially the same terms as the family office invests, but does not
invest in other funds advised by the family office, and whose assets as
to which the family office directly or indirectly provides investment
advice represents, in the aggregate, not more than 5 percent of the
value of the total assets as to which the family office provides
investment advice; provided that a family office that would not be a
family office but for this paragraph (c) shall be deemed to be an
investment adviser for purposes of paragraphs (1), (2) and (4) of
section 206 of the Act.
(d) Definitions. For purposes of this section:
(1) Control means the power to exercise a controlling influence
over the management or policies of a company, unless such power is
solely the result of being an officer of such company.
(2) Family client means:
(i) Any family member;
(ii) Any key employee;
(iii) Any charitable foundation, charitable organization, or
charitable trust, in each case established and funded exclusively by
one or more family members or former family members;
(iv) Any trust or estate existing for the sole benefit of one or
more family clients;
(v) 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;
(vi) Any former family member, provided that from and after
becoming a former family member the individual shall not receive
investment advice from the family office (or invest additional assets
with a family office-advised trust, foundation or entity) other than
with respect to assets advised (directly or indirectly) by the family
office immediately prior to the time that the individual became a
former family member, except that a former family member shall be
permitted to receive investment advice from the family office with
respect to additional investments that the former family member was
[[Page 63763]]
contractually obligated to make, and that relate to a family-office
advised investment existing, in each case prior to the time the person
became a former family member; or
(vii) Any former key employee, provided that upon the end of such
individual's employment by the family office, the former key employee
shall not receive investment advice from the family office (or invest
additional assets with a family office-advised trust, foundation or
entity) other than with respect to assets advised (directly or
indirectly) by the family office immediately prior to the end of such
individual's employment, except that a former key employee shall be
permitted to receive investment advice from the family office with
respect to additional investments that the former key employee was
contractually obligated to make, and that relate to a family-office
advised investment existing, in each case prior to the time the person
became a former key employee.
(3) Family member means:
(i) The founders, their lineal descendants (including by adoption
and stepchildren), and such lineal descendants' spouses or spousal
equivalents;
(ii) The parents of the founders; and
(iii) The siblings of the founders and such siblings' spouses or
spousal equivalents and their lineal descendants (including by adoption
and stepchildren) and such lineal descendants' spouses or spousal
equivalents.
(4) Former family member means a spouse, spousal equivalent, or
stepchild that was a family member but is no longer a family member due
to a divorce or other similar event.
(5) Founders means the natural person and his or her spouse or
spousal equivalent for whose benefit the family office was established
and any subsequent spouse of such individuals.
(6) Key employee means any natural person (including any person who
holds a joint, community property, or other similar shared ownership
interest with that person's spouse or spousal equivalent) who is an
executive officer, director, trustee, general partner, or person
serving in a similar capacity of the family office or any employee of
the family office (other than an employee performing solely clerical,
secretarial, or administrative functions with regard to the family
office) who, in connection with his or her regular functions or duties,
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.
(7) Spousal equivalent means a cohabitant occupying a relationship
generally equivalent to that of a spouse.
Dated: October 12, 2010.
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010-26086 Filed 10-15-10; 8:45 am]
BILLING CODE 8011-01-P