The definition of a family office’s “family clients” must be inclusive enough to encompass all of the clients and arrangements that are typically present in a single-family office, the AICPA said.
The suggestion was among comments submitted by the Institute on Tuesday on a proposed SEC rule defining family offices, part of its rulemaking to implement amendments to the Investment Advisers Act of 1940 (Advisers Act) made by the Dodd-Frank Wall Street Reform and Consumer Protection Act, PL 111-203 (Reform Act). The Reform Act was enacted last July and contains sweeping new provisions regarding registration and regulation of investment advisers. The seven-page letter, signed by chairs of the Institute’s Tax Executive Committee and Personal Financial Planning Committee, generally supports the proposed rule’s approach and provides suggestions for modifications and clarifications. The SEC plans to adopt its final rules on family offices between April and July 2011.
The Reform Act provides a general exemption of family offices from the definition of an investment adviser subject to registration and regulation. The SEC issued the proposed rule in October.
As the SEC explained in its release, family offices are entities established by wealthy families to manage their wealth, plan for their families’ financial future and provide other services to family members. The proposed rule seeks to define family offices for purposes of the exemption in the Advisers Act. Previously, many family offices have been considered exempt from the Advisers Act under its exclusion for “private advisers,” which the Reform Act repealed. Fundamentally, the proposed rule defines a family member as the founder (the person for whose benefit the family office was established), and current and subsequent spouse(s), plus their parents and lineal descendants (including by adoption and stepchildren) and those descendants’ spouses, as well as the founder’s siblings and their spouses and lineal descendants and their spouses. The Institute suggested including grandparents of the founder, as well as widows and widowers of family members.
Other specific recommendations include:
- Family members should be allowed to continue making new investments through a family office after they become former family members, such as by divorce. The proposed rule would allow them only to retain their investments made while members of the family.
- A family client should include any entities and organizations that are majority owned or established, directly or indirectly, by family clients, or majority controlled, directly or indirectly, by family clients, the AICPA said. This would provide a more flexible and inclusive definition that is necessary to accommodate many common arrangements typically established and utilized by high net worth families. Some entities, such as families’ private foundations, that accept limited donations from non-family members are common as family clients and should continue to be so considered, as long as they are majority owned, established or controlled, directly or indirectly, by family clients, the Institute suggested.
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Along the same lines, the AICPA does not support the proposed rule’s requirement that family offices themselves be wholly owned and controlled by family members. Rather, certain key employees often are permitted to hold non-controlling ownership interests as a long-term retention and incentive tool, and that practice should be allowed to continue. Likewise, a trust or closely held family entity often has an ownership interest in the family office. Therefore, the AICPA said, the rule should require either majority ownership, directly or indirectly, by family members, or majority control, directly or indirectly, by family members.
- The proposed rule permits “key employees” of the family office to also receive investment advice. The AICPA recommends that the rule’s provision regarding persons serving in a similar capacity be construed broadly to include board members and other long-term advisers. The Institute does not support the rule’s proposed 12-month initial probationary period before key employees may make investments with the family office.
- Additional clarification is needed on what constitutes an “involuntary transfer” of assets of the family office to a non-family client under which the rule proposes a four-month grace period, which the AICPA said should instead be at least 12 months.
Two other matters not addressed in the proposed rule should also be addressed by the SEC, the AICPA said:
- In some instances, family offices provide investment advisory services without compensation to persons who may not be considered family clients within the proposed rule. The SEC should specifically allow such arrangements, similar to an existing safe-harbor definition of clients of investment advisers generally (Rule 203(b)(3)-1(b)(4)).
- The rules should provide relief for, and procedures to correct, inadvertent violations.
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