What is a Family Office?

The term “family office” has multiple meanings in the securities universe.  Here we discuss the family office exemption from the definition of “investment adviser” under the Investment Advisers Act (the “Act”).  Limited regulatory oversight is one of several benefits a financial professional gets from falling within the exemption.

How is a “family office” defined?

Securities and Exchange Commission (“SEC”) Rule 202(a)(11)(G)-1 (“Family Office Rule”) excludes a “family office” from the definition of  investment adviser when certain criteria are met.  To be a “family office,” a company must:

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

The Act provides for a broad definition of “company” and therefore the organizational structure of the family office could be any number of entities including: a corporation, a partnership, or any organized group of people, whether incorporated or not.  Furthermore, the Family Office Rule treats directors, partners, members, managers, trustees, and employees acting within their scope of employment with the family office as the equivalent to the family office.  As such, any person working for a family office, to the extent they are giving investment advice, are excluded from the definition of investment adviser.

Who qualifies as “family clients”?

The Family Office Rule requires that the family office have “no clients other than family clients.”  SEC guidance indicates that the clause should be read as “no other [investment advisory] clients” and therefore the family office could provide other services (such as tax or accounting services) to those who fall outside of the family client definition.  The Family Office Rule explicitly lists out multiple categories of persons or entities that fall within the definition of family client.

Family clients include any of the following groups:

Family member or former family member includes all lineal descendants of a common ancestor (may be living or deceased) as well as current and former spouses or spousal equivalents of those descendants, provided that the common ancestor is no more than 10 generations removed from the youngest generation of family members.  All children by adoption and current and former stepchildren also are considered family members.

Key employees or former key employees are any natural person (including any key employee’s spouse or spouse equivalent who holds property jointly with the key employee) who is an executive officer, director, trustee, general partner, or person serving in a similar capacity of the family office or its affiliated family office or any employee of the family office or its affiliated family office (other than an employee performing solely administrative functions with regard to the family office) who, 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 for at least 12 months.

Non-profit organizations include any non-profit organization, charitable foundation, charitable trust (including charitable lead trusts and charitable remainder trusts whose only current beneficiaries are other family clients and charitable or non-profit organizations), or other charitable organization, in each case for which all the funding such an organization holds comes exclusively from one or more other family clients.

Estates and trusts include the estate of a family member, former family member, key employee, or former key employee. Any trust can be a family client if: (a) each trustee or other person authorized to make decisions with respect to the trust is a key employee; and (b) each settlor or other person who has contributed assets to the trust is a key employee or the key employee’s current and/or former spouse or spousal equivalent who, at the time of contribution, holds joint property (or other similar shared ownership interest) with the key employee.

Companies any company wholly owned (directly or indirectly) exclusively by, and operated for the sole benefit of, one or more other family clients qualifies as family client, so long as, 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.

Wholly Owned and Exclusively Controlled Requirements

One of the more nuanced aspects of the Family Office Rule is that the family office must be wholly owned by family clients and in the exclusive control (direct or indirect) of one or more family members and/or family entities. For example, the SEC found that the family office would be exclusively controlled if four of the seven board of directors for the family office were family members.  However, the SEC has found that if a board of directors was comprised of non-family members or entities, but who were all appointed by family members that have the right to appoint, terminate, or replace the directors, this would not constitute exclusive control.

Furthermore, a family office must be wholly owned by family clients as defined by the Family Office Rule.  Here the SEC has stated that a non-family client owning nonvoting shares would cause the office to lose its qualification as a family office– i.e., control cannot be shared with individuals or companies that are not family members or family entities.

Does Not Provide Investment Advice to Public

The intent of the Family Office Rule is to provide an exemption from the definition of investment adviser for those working with the wealth of a single family and its related entities.  As such, the exemption is lost if the family office holds itself out to the public as an investment adviser.

Conclusion

As with many securities regulations the Family Office Rule is filled with pitfalls for investment professionals who do not fully understand its nuances.  However, an exclusion from the definition of investment adviser should be considered for those financial professional’s seeking to increase their flexibility when serving his or her wealthy family clients.

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