Family Office and Wealth Planning Services

Last month we discussed how a Family Office is exempt from the definition of “investment adviser” and, therefore, exempt from registration requirements. This month, we will address the type of advisory services commonly referred to as “Family Office and Wealth Planning Services” and how that differs from the exemption provided by Securities and Exchange Commission (“SEC” or “Commission”) Rule 202(a)(11)(G)-1.

Family Office and Wealth Planning Services

Typically, “family office and wealth planning services” are designed to help clients organize their financial situation and plan for the successful transfer of wealth to the next generation in the most tax-advantaged manner. Such services generally include, but are not necessarily limited to, financial planning in the following areas:

• Family Continuity;
• Estate Planning and Trustee Oversight;
• Integrated Tax and Financial Planning;
• Lifestyle Management;
• Family Philanthropy; and
• Risk Management.

In SEC Release number IA-1092, the Commission Staff interpreted the definition of “investment adviser” to include persons who advise clients concerning the relative advantages and disadvantages of investing in securities in general as compared to other investments. The definition also includes persons who, in the course of developing a financial program for a client, advises a client as to the desirability of investing in, purchasing or selling securities, as opposed to, or in relation to, any non-securities investment or financial vehicle would also be "advising" others within the meaning of Section 202(a)(11).

Custody of Client Funds and Securities

From a regulatory and operations perspective most investment advisers find “custody” to be a significant challenge. Under SEC rule 206(4)-2(c)(1) an adviser has custody of client assets, and therefore must comply with the Custody Rule, when it holds, "directly or indirectly, client funds or securities or [has] any authority to obtain possession of them." As such, a family office and wealth planning services adviser would have custody if it had access to the funds of the client family. For example, an adviser would have custody of client funds where that adviser had check writing capabilities on a client account.

Having custody of client securities or funds triggers the Custody Rule – SEC Rule 206(4)-2. An adviser that is deemed to have custody must have a qualified custodian maintain those funds and securities. Furthermore, the client must receive notice that the account has been opened and the client must receive account statements on an ongoing basis. The most onerous provision of the Custody Rule, however, requires that the account where the client securities or funds are held be subject to verification by an independent public accountant at least annually.

Conflicts of Interest

Conflicts of interest must be disclosed to clients and potential clients. Furthermore, the adviser’s compliance policies and procedures should identify the risk(s) and proscribe specific steps that should be taken to mitigate risk(s). Advisers that offer multifaceted family office and wealth planning services will be confronted with interest conflicts that must be managed. All registered advisers are subject to the fiduciary requirements of the Investment Advisers Act of 1940. Where offered services present a conflict of interest, or even the appearance of a conflict of interest, the adviser must disclosure such conflicts and take reasonable steps to mitigate the risks.

• Professional Services. Where the adviser offers professional services (such as tax or legal) a conflict of interest arises because the services could be obtained away from the adviser at less cost to the client.
• Brokerage Services. Where an adviser has an affiliated broker dealer, a conflict of interest appears because persons providing investment advice on behalf of adviser who are registered representatives of the broker dealer have an incentive to effect securities transactions through the broker dealer for the purpose of generating commissions.
• Trusts, Power of Attorney (Control and Benefit Issues). Advisers that offer family office and wealth planning services often find that they are being asked to enter roles of trust. Where an adviser allows themselves to benefit from or control over client interests a conflict of interest arises that needs to be mitigated.Where an adviser finds themselves in a position of conflict relative to their client’s interests, that adviser may find it necessary to: compare the services offered internally with those offered by third-party vendors; subject conflicted transactions to independent review; or, remove themselves from the conflicted transaction.

Other Regulatory Concerns

Advisers offering family office and wealth planning services may also have regulatory risk exposure relating to the following:

• Insider Trading. Wealthy clients may sit on the boards, or act as executives, of publicly traded companies and therefore have access to insider information. Advisers to these client need to make sure they are not facilitating insider trading when trading. Advisers may want to consider blackout lists or other steps to mitigate this risk.
• Privacy. Above the access that is routinely given to advisers regarding their clients, an adviser with a close relationship to their client may be granted access to information regarding the mental or physical well-being of that client (such as medical records). Advisers will want to make sure that steps are in place to prevent such information from being viewed or obtained by inappropriate parties.
• Gifts and Entertainment. Advisers are obligated to have policies and procedures in place to mitigate the risks associated with the giving and receiving of gifts and entertainment.

Given the close relationship that many advisers develop with their clients a risk of undue influence may arise. An adviser will want to ensure that appropriate checks are in place to ensure that the giving or receiving of gifts does not unduly influence either the client or adviser.

Each adviser business model is unique and each adviser needs to have a solid understanding of the associated risks. Understanding the areas of risk that the client may be exposed to is also critical to providing comprehensive family office and wealth planning services to wealthy clients.

The Family Office Exemption

As discussed last month, advisers that work exclusively with a single family’s wealth, that do not hold themselves out as investment advisers and who meet certain other requirements are not required to register as investment advisers. However, a typical family office and wealth planning services adviser does not fall within the narrow confines of this exemption from registration. As an overview, an adviser only falls within the family office exemption if the adviser:

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

The family office exemption analysis can be very complicated. Contact you consultant if you have any questions.

Conclusion

Advisers reaping the numerous benefits of the family office and wealth planning services model must realize and mitigate the risks. Failing to comply with the Custody Rule or to protect clients from conflicts of interest can lead to significant regulatory exposure.

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