By David Drake
In the past few years, several changes have been made in the family office regulatory environment. Family offices that were not registered with the US Securities and Exchange Commission (SEC) in 2011 had to reassess their acquiescence with the latter’s regulations, which restricted family offices qualifying for exemption of the Registered Investment Advisors. The Final Rule 275.202 (a)(11)(G)-1, that came to effect on 22 June 2011, outlined the family offices excused from registration requirements contained in the Investment Advisers Act of 1940, and amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act -“Dodd-Frank Act” in July of 2010.
As Registered Investment Advisers, family offices are subject to SEC’s oversight, and are expected to observe SEC’s regulations and reporting requirements with regard to annual disclosures, compliance programs, record keeping, solicitation agreements, plus marketing and advertising. “This is important because investors are looking for a well-grounded, long-term commitment, and compliance to regulations is part of the grounding process,” says Bruce H. Lipnick, Asset Alliance’s Founder and CEO. Even so, the Investment Advisers Act of 1940 exempts private advisers serving less than 15 clients that neither conduct themselves as investment advisers in public nor advise Registered Investment Companies. At the moment, many family offices do, in fact, qualify and depend on the exemption for private advisers to evade SEC’s oversight and registration.
These exemptions include all Single Family Offices (SFOs), and some Multi-Family Offices (MFOs), serving less than 15 wealthy families or individuals. However, there are rules that guide the client counting process. For instance, a US-based adviser is required to include investors of all nationalities, while a non-US adviser only needs to take into account clients who are US residents. Related individuals sharing the same residence are counted as one client, and legal entities such as corporations, trusts, and limited liability companies are counted as single clients as well.
Family Office Regulations
Apart from the SEC, there are other regulations that guide the operations of family offices. These are:
The Dodd-Frank Exemption Regulation
The Dodd-Frank Act of 2010 sets the platform for SEC to control investment funds, collective vehicles and advisers. Based on this Act, the regulation of SFOs as investment advisers is exempted upon satisfying SEC’s exemption criteria. To qualify for exemption, a family office has to provide advisory services to family clients only, and be fully owned and controlled by family entities or members. Moreover, the family office should not present itself as an investment adviser to the public. The exemption process is quite complex. For example, most family offices have to exclude distant relatives and friends from trusts, in addition to collective investment vehicles, in order to qualify for exemption. These rules may apply to foreign families if they have family members residing, or owning property, in the US.
The Tax Disclosure Regulation
The US Foreign Account Tax Compliance Act (FATCA) provides detailed tax, withholding tax and reporting requirements with respect to payments of specific incomes to financial entities or institutions abroad from US sources. Due to these regulations, non-US families may find their financial accounts, in which they have vested interests, subjected to US reporting requirements. In the event that one of the family members pays tax in the US, she or he has complete interest in that account as well.
Anti-Money Laundering Regulations
With the ever rising anti-money laundering rules and ‘know your client’ requirements, financial institutions, such as investment funds and banks, are reaching out for details regarding ownership of investor entities and accounts. The focus of the Foreign Account Tax Compliance Act is on reporting accounts where US taxpayers have considerable interest. This opened an avenue for the government to request more details regarding asset ownership from wealthy individuals or family members, since many of them opt to keep these information to themselves. Family offices have to device strategies to address these requests from financial entities for purposes of transparency, at the same time guarding their privacy.
The Anti-Spinning Regulation
Rule 5131 of the Financial Industry Regulatory Authority (FINRA), commonly referred to as the ‘anti-spinning’ rule, obligates regulated brokers in the US to study investment accounts to determine whether the account owners are capable of making new investments. This rule aims to prevent brokers from allowing new investments to fall into the wrong hands; those with the capacity to involve FINRA member or affiliates to provide services in investment banking. It also prevents regulated brokers from allocating new issues to accounts of public companies whose directors, or any person supported directly by them, have absolute interest during the period in which they make use of investment banking services as FINRA members. This rule affects most family offices because its members are supported financially by a director or executive director of a large private or public company. Also, due to profitability or financial holdings, most single family offices are non-public covered companies.
Regulation on Reporting Beneficial Ownership
There are certain regulations for wide reporting by those who beneficially hold or exercise investment decisions over considerable amounts of publicly-traded securities. Often, such disclosures are available publicly, and should include details on direct security holders as well as those holder’s indirect and direct owners. This discloses a family structure and the different levels of ownership. Due to these rules, wealthy individuals and family offices can lose their privacy in terms of the value and identity of securities, as well as the multilevel structure that hold these securities intact.
With the exception of the Dodd-Frank Act, these regulations affect both single family and multi-family offices. However, a single family office has still to meet the exemption criteria laid out in the Dodd Frank Act to qualify for exemption from SEC oversight.