Tag: Family Office

The SEC, “Spousal Equivalents” and the Family Office

The SEC now recognizes “spousal equivalents” defined as “cohabitants occupying a relationship generally equivalent to that of a spouse.” Before wondering if the federal government is making big strides, keep in mind that this recognition is limited to the new Family Office Rule (.pdf).

Dodd-Frank created a new exemption for Family Offices. Previously they typically operated under the 15 clients rule that was repealed by Dodd-Frank or a private ruling from the SEC. Dodd-Frank left it up to the SEC to define a “family office.”

Rule 202(a)(11)(G)-1 contains three general conditions to fitting into the Family Office Exemption. First, the family offices may only provide advice about securities to certain “family clients.” Second, family clients must wholly own the family office and family members and/or family entities must control the family office. Third, a family office cannot hold itself out to the public as an investment adviser.

Th rule inevitably leads to a definition of “family.” Too narrow and many family offices would be excluded. Too broad and every investor will find an ancestor from the Mayflower. The SEC decided on a 10 generation limit.

The rule treats lineal descendants and their spouses, spousal equivalents, stepchildren, adopted children, foster children and persons who were minors when another family member became their legal guardian as family members.

I think it was bold move of the SEC to include spousal equivalents. They brush aside the Defense of Marriage Act argument: Because the term “spouse” is not defined in the rule and a “spousal equivalent” is identified as a category of person, separate and distinct from a “spouse,” that meets the definition of a “family member”….  DOMA provides that in “determining the meaning of any Act of Congress, or of any ruling, regulation, or interpretation of the various administrative bureaus and agencies of the United States…the word ‘spouse’ refers only to a person of the opposite sex who is a husband or wife.” 1 U.S.C. 7.

The failure of a family office to be able to meet the conditions of the new rule will not preclude the office from providing services to family members. But, the family office will need to find another exemption, register under the Advisers Act or seek an exemptive order from the SEC.

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The image is the Spousal Equivalent Badge available from Zazzle.

The Family Office Exemption under the Investment Advisers Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act wiped out the exemption enjoyed by most private funds. I’m still waiting to see how the SEC will define a “venture capital fund manager.” In the meantime, the SEC has published its proposed rule defining a “family office” and its exemption from registration under the Investment Advisers Act.

Historically, family offices have not been required to register with the SEC under the Advisers Act because of the same exemption used by private funds. The Dodd-Frank Act removed that “small adviser” exemption under section 203(b)(3) to enable the SEC to regulate hedge fund and other private fund advisers, but includes a new provision requiring the SEC to define family offices in order to exempt them from regulation under the Advisers Act.

“Family offices” are established by wealthy families to manage their wealth and provide other services to family members. That leaves the fabulously wealthy time to go yachting and leaves others to manage their securities portfolios, plan for taxes, worry about accounting services, and to directing charitable giving. The issue is the the family office management of securities.

In the past, the SEC has issued dozens of exemptive orders for family offices who requested them, removing them from the registration and supervision of the SEC. The proposed rule 202(a)(11)(G)-1 would largely codify the exemptive orders. Most of the conditions of the proposed rule are designed to restrict the structure and operation of a family office relying on the exemption to activities unlikely to involve commercial advisory activities, while still allowing family office activities involving charities, tax planning, and pooled investing.

(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 section 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.

The key is how the SEC defines a family member:

(d) (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.

I guess that some family offices will be cutting off some distant relations to get under this definition. For “less-beloved” family members, the family office management can use SEC regulation as an excuse to kick them out.  Of course, they can still seek and exemptive order from the SEC if they don’t fit under this definition.

The comments should involve a whole new area for the SEC: family law.

As I expected, this exemption is of no value to private funds look for a safe harbor from SEC registration.

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