Staff of SEC Division of Investment Management Clarifies the Scope of the Family Office Rule

Family offices historically have been considered “investment advisers” as defined in the Investment Advisers Act of 1940 (Advisers Act) because they provide investment advice for compensation.  However, family offices historically have avoided registration by availing themselves of the private adviser exemption in Section 203(b)(3) of the Advisers Act or by seeking and obtaining exemptive relief from the SEC.  Under the Dodd-Frank Act, Congress eliminated the private adviser exemption and directed the SEC to adopt a definition of single family office that would be “consistent with previous exemptive policy” and recognize “the range of organizational, management, and employment structures and arrangements employed by family offices.”  On June 22, 2011, the SEC adopted Rule 202(a)(11)(G)-1 under the Advisers Act (Family Office Rule).  The Family Office Rule generally provides that family offices are excluded from the definition of investment adviser under the Advisers Act and defines family offices for purposes of the exclusion.  Under the Family Office Rule, an entity is a family office if it: (1) has only family clients; (2) is wholly owned and exclusively controlled by family members or family entities; and (3) does not hold itself out to the public as an investment adviser.  For a comprehensive discussion of the Family Office Rule, see “Developments in Family Office Regulation: Part Three,” Hedge Fund Law Report, Vol. 4, No. 23 (Jul. 8, 2011).  So, as a matter of administrative law, Congress adopted a general principle with respect to family offices and the SEC put that principle into practice via rulemaking.  But while rules are more specific than laws, even rules often fail to capture the rich variety of factual circumstances to which they apply.  This is particularly the case with respect to family offices, a vast and heterogeneous group of entities engaged in a wide range of activities.  Accordingly, to offer industry participants more guidance on applying the Family Office Rule, the staff of the SEC’s Division of Investment Management recently published responses to five categories of questions relating to the scope of the Family Office Rule.  Specifically, the staff responded to questions on: (1) ownership and control of family offices; (2) key employees; (3) family members; (4) non-advisory services; and (5) the Family Office Rule’s grandfathering permission.  This article summarizes the staff responses.  These staff responses are important to two general categories of hedge fund managers: those that have or solicit investments from family offices, and those considering conversion to a family office format.  With respect to investments in hedge funds by family offices, see “Public Pension Funds and Endowments Increase Allocations to Hedge Funds, While Allocations from Family Offices Slide,” Hedge Fund Law Report, Vol. 4, No. 36 (Oct. 13, 2011).  And with respect to conversion by hedge fund managers to a family office format, see “Legal Mechanics of Converting a Hedge Fund Manager to a Family Office,” Hedge Fund Law Report, Vol. 4, No. 43 (Dec. 1, 2011).

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