Investment banks and brokerage firms aren't the only ones scrambling to prepare for the post-Dodd-Frank Act regulatory environment.
Family offices, which provide investment management and other financial services to ultrawealthy families, also face major challenges in dealing with the legislation.
The bombshell in the Dodd-Frank Act for family offices was the revocation of the “less-than-15-client exemption” for private investment advisers. That rule allowed single-family offices to avoid registration with the Securities and Exchange Commission under the Investment Advisers Act of 1940, and the disclosures and costs that come with it.
As long as an entity provided investment management services for fewer than 15 clients, it didn't have to register with the SEC. That exemption is gone, and family offices that formerly flew under the radar have until March 31 either to comply with a tighter definition of an exempt private adviser or submit to SEC regulation.
The new SEC definition requires that advisory services be provided exclusively to family members. In-laws, family friends and most employees of the office are out, meaning no more co-investing opportunities for outsiders.
“Dodd-Frank has forced a lot of family offices to do some soul-searching,” said Robert Testa, a senior analyst at Cerulli Associates Inc. who focuses on the family-office market.
“We don't see a mass exodus from the single-family-office structure,” he said, “but most of these organizations are restructuring to comply with the new regulations — outsourcing investment management functions or registering as a private trust company.”
PRIVACY ADVANTAGE
Very few appear to be choosing the SEC registration route, said John Duncan, a lawyer with Kozusko Harris Vetter Wareh Duncan LLP who specializes in setting up private trust companies for wealthy families.
A big part of the attraction of family offices is the privacy that they afford their clients. The continuing disclosures and audit requirements involved with SEC registration defeat that purpose, Mr. Duncan said.
“Family offices that have members in the investment world working in registered businesses may be a little more comfortable with the idea,” Mr. Duncan said. “But the reluctance to register is high.”
In implementing the provisions of the Dodd-Frank Act, Congress left the task of defining an exemption for family offices to the SEC.
The commission's first effort, issued in 2010, likely would have disqualified about 90% of family offices.
It drew intense criticism, and successful lobbying from private-investor groups led to a new, more manageable definition issued last July.50% WILL QUALIFY
Perhaps 50% of the approximately 2,500 to 3,000 single-family offices will qualify for the exemption under the new definition, Mr. Duncan said.
Of those that are left, only about 10% will opt to register as an adviser, he said.
That leaves somewhere in the neighborhood of 1,125 to 1,350 family offices that have to figure out a strategy either to fit within the new SEC definition or otherwise avoid having to register.
They essentially have four options, said Mariann Mihailidis, managing director of councils at the Family Office Exchange, which provides advocacy, research and other services to 450 wealthy member families:
• They can pare down to the immediate family the clients to whom they provide investment management services.
• They can ask the SEC for an exemption letter. But if the family office doesn't fit under the new definition, the likelihood that the SEC will grant an exemption based on other arguments is slim.
• They can outsource the investment management function entirely. That would include any investment manager search functions or performance-reporting activities.
• Finally, they can form a private trust company. This is an expensive but increasingly popular option, said Mr. Duncan, who has helped scores of families set up private trust companies over the past decade. Such companies can continue to perform the activities the family office provided without having to jump through federal regulatory hoops. Private trust companies are regulated under state law, with states such as Nevada, New Hampshire and South Dakota offering particularly friendly environments.
“A lot of our families looked at their offices and felt that they fell within the exemption definition,” Ms. Mihailidis said.
“Others have adjusted their client bases or outsourced services. Still others have decided to register [as an adviser] or set up a private trust company,” she said.
The heavier compliance burden isn't the only factor driving change in the family office community. The financial crisis and the increasing complexity of the investment landscape have forced single-family offices to consider new options, including looking outside the organization for help with alternative investments and international diversification.LOOKING AT COSTS
“Since 2008, we've had family offices come to us and say that they don't have the depth of talent and access to market power to handle the investment function successfully anymore,” said Steve Barimo, chief marketing officer for GenSpring Family Offices LLC, one of the fastest-growing multifamily offices in the industry. “They're taking an intense look at their costs and using external providers like us to help reduce them.”
Regulatory reform essentially has added further steam to an investment management outsourcing trend at single-family offices and a stronger demand for service from multifamily offices that can spread costs over more clients."A BOTTOMLESS PIT'
“A single-family office can seem like a bottomless pit at times,” said Steve Braverman, chief executive of Pathstone Family Office LLC.
“A family with $100 million in assets can easily spend $1 million annually on a family office. We can do it for $500,000 to $600,000 per year,” Mr. Braverman said.
That said, traditional family offices won't go the way of the dinosaur.
“There's a lot of history to family offices,” Mr. Barimo said. “They don't want to just close up shop.”
aosterland@investmentnews.com
